Is Coinstar Destined for Greatness?

Every investor can appreciate a stock that consistently beats the Street without getting ahead of its fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with improving financial metrics that support strong price growth. Let's take a look at what Coinstar's (OUTR) recent results tell us about its potential for future gains.

What the numbers tell you
The graphs you're about to see tell Coinstar's story, and we'll be grading the quality of that story in several ways.

Growth is important on both top and bottom lines, and an improving profit margin is a great sign that a company's become more efficient over time. Since profits may not always be reported at a steady rate, we'll also look at how much Coinstar's free cash flow has grown in comparison to its net income.

A company that generates more earnings per share over time, regardless of the number of shares outstanding, is heading in the right direction. If Coinstar's share price has kept pace with its earnings growth, that's another good sign that its stock can move higher.

Is Coinstar managing its resources well? A company's return on equity should be improving and its debt-to-equity ratio declining if it's to earn our approval.

By the numbers
Now, let's take a look at Coinstar's key statistics:

CSTR Total Return Price data by YCharts.

Source: YCharts. * Period begins at end of Q3 2009.

CSTR Return on Equity data by YCharts.

Source: YCharts. * Period begins at end of Q3 2009.

How we got here and where we're going
Coinstar earns all but one of the seven possible passing grades, and that one is likely to return to the right direction next time we examine it -- Coinstar ended 2009 with a steep one-time drop in quarterly profit, and has slowly been trending back up ever since. Will the company be able to maintain its momentum elsewhere to earn a rare perfect score when we look at it again in a year? Let's see what's in store.

The most compelling story in Coinstar's near future will be the rollout of Redbox Instant, a partnership with Verizon (VZ -0.44%), although it may not be so near after all. Multiple delays look to keep the service in beta testing until spring, and the longer Coinstar waits to beef up its digital offerings, the less compelling it looks next to Amazon.com's (AMZN -1.61%) Prime service or Netflix's (NFLX 1.97%) industry-leading streaming selection. The problem is that streaming services appear to be losing their luster just as Coinstar's jumping in. Both Netflix and Coinstar suffered a drop in traffic in the fourth quarter of 2012. While that might be damaging, it could just be a byproduct of natural disasters cutting out Internet access for millions of East Coasters. The financial and subscriber numbers for both services continue to improve.

Coinstar is going to have to pony up to compete with either service on a streaming basis. Make that Clydesdale up -- Netflix is already spending $2 billion per year in streaming content acquisition costs, and Amazon has committed nearly $1 billion to its own efforts. Considering that $2 billion is as much revenue as Coinstar earned over the trailing 12 months, it will be a tall order to lure committed Netflix or Prime subscribers to Redbox Instant without destroying profitability. Coinstar's going to have to do this with a brand-new CEO, as the man who guided Redbox to a 10-fold increase in rentals  over four years retired at the beginning of January.

Coinstar is currently very cheap -- both P/E and price-to-free cash flow ratios are in the single digits. But that's because the market expects the company's bread-and-butter DVD rentals to tank over the long term, and the statistics bear this out. To succeed, Coinstar will have to prove that it has another ace up its sleeve that's as valuable as DVD kiosks were years ago.

Putting the pieces together
Today, Coinstar has many of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.