Is Travelzoo Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Travelzoo (TZOO -1.33%) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Travelzoo's story, and we'll be grading the quality of that story in several ways:

• Growth: Are profits, margins, and free cash flow all increasing?
• Valuation: Is share price growing in line with earnings per share?
• Opportunities: Is return on equity increasing while debt to equity declines?
• Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Travelzoo's key statistics:

TZOO Total Return Price data by YCharts.

Source: YCharts. *Period begins at end of Q2 2010.

TZOO Return on Equity data by YCharts.

Source: YCharts. *Period begins at end of Q2 2010.

How we got here and where we're going
Travelzoo puts together a really strong performance, narrowly missing out on a perfect score only because stock growth has outpaced the growth of EPS during our tracked period. The company's revenue and free cash flow have both increased substantially over the past three years, and its stock has hit new peaks since emerging from the crash of 2008. The consistency of its fundamental growth makes it even more appealing, as its price-to-free cash flow ratio is just under 15. This is a strong performance, but can Travelzoo keep up the progress? Let's dig a little deeper to find out.

In its first quarter results, Travelzoo reported a year-over-year increase of 7% in revenue. In addition, Travelzoo's strong performance across North America and Europe sent net profit soaring by almost 50% year over year. A similar performance was seen in Travelzoo's second quarter, which beat both top- and bottom-line estimates. The company has been quite successful in expanding its geographical reach, especially in Europe, which is currently suffering from a grinding economic slowdown. However, CEO Chris Louglin anticipates that Travelzoo's new hotel booking platform, which is scheduled to launch by the end of this year, will boost subscriber growth.

This is just another step in the transformation of Travelzoo from a flash-deal site to a more complete travel-booking platform. It can't quite compete with priceline.com yet, and despite starting from a much smaller base, Travelzoo underperforms Priceline on many key metrics. When we examined Priceline on the same metrics last year, we found that revenue, free cash flow, and net income were growing at a faster clip than they are for Travelzoo now. That remains true today.

Last month, Travelzoo's management announced an unusual stock split, which intends to cut "shareholder account administration costs." Fool contributor Rich Smith points out that a 1:25 reverse stock split transaction will effectively cash out small shareholders who own fewer than 25 shares of the company. Following the reverse stock split, Travelzoo will immediately execute a 25:1 forward split, thereby reducing the total number of stakeholders from more than 90,000 to fewer than 10,000. This reverse/forward stock split should certainly reduce administrative costs if it cuts out most of the company's shareholders. It doesn't do anything to enhance Travelzoo's future business strategy, but it's a clever plan for shaving down the costs of doing business as a public company.

Putting the pieces together
Today, Travelzoo 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.