Is Macy's 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 Macy's, (M 0.16%) fit the bill? Let's 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 Macy'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 look at Macy's key statistics:

M Total Return Price data by YCharts

Source: YCharts.
*Period begins at end of Q4 (Oct.) 2010.

M Return on Equity (TTM) data by YCharts

Source: YCharts.
*Period begins at end of Q4 (Oct.) 2010.

How we got here and where we're going
We first looked at Macy's last year, and it has grabbed one more passing grade in its second assessment, finishing up with seven out of nine passing grades. Although the company's revenue growth has been rather sluggish over the past few quarters, Macy's has done a fantastic job of improving its margins. However, the company hasn't been able to prop its free cash flow level, which has barely budged in three years. Despite this apparent weakness, Macy's shareholders have enjoyed solid growth over the past three years thanks to the huge earnings rebound. How might Macy's push its revenue growth even higher while mustering some serious improvement on its free cash flow? Let's dig a little deeper to find out.

Over the past few years, Macy's has easily outperformed competitors such as J.C. Penney (JCPN.Q) and Kohl's (KSS 4.53%), thanks to deals with affordable-luxury brands True Religion and Fossil and a superior online clothing marketplace. Macy's has also made inroads on the teen apparel and accessories segment, forcing American Eagle, Aeropostale, and Abercrombie & Fitch to use higher discounts on merchandise in order to entice young consumers. Fool contributor Sean Williams notes that the clothing sector was plagued by terrible back-to-school sales this summer, which largely stemmed from the U.S. debt ceiling crisis. As a result, Aeropostale and A&F's same-store sales fell 15% and 8%, respectively, but Macy's experienced a comparatively negligible 0.8% decline in August. The difference in strategies has produced a clear winner -- only Macy's has outperformed the indexes during the three-year tracking period:

M Total Return Price data by YCharts

Fool contributor Robert Hanley points out that Macy's has placed a bet on its in-store management teams, who will now be responsible for selecting a favorable product mix, a role previously undertaken at the corporate level. In addition, the company has ambitious plans to expand in-store technology capabilities across more than 500 stores, which will help sales staff process online orders. Macy's rival Kohl's, which has a more middle-class customer base, is focusing on open store layouts as well as modifying stores to fulfill online sales. Fool contributor Adam Levy notes that Macy's seems poised to benefit from the upcoming holiday season, as it has hired 83,000 additional employees nationwide, up 4%, compared to last year. According to the National Retail Federation, seasonal sales are expected to grow 3.9% between November and December, up from 3.5% in 2012.

On the other hand, J.C. Penney's attempted partnership with Martha Stewart Omnimedia (MSO.DL), which gave the former the rights to setup latter's stores inside Penney locations, caused quite a stir when Macy's filed suit against Martha Stewart, alleging that it owned sole rights to Stewart's collection. However, presiding Judge Oing permitted J.C. Penney to sell non-branded Stewart's merchandise worth $100 million within its stores. J.C. Penney's now also betting on Shopkick's geolocation and geofencing mobile app, which offers unique shopping experience to customers as soon as they enter its stores. Fool contributor Rich Duprey notes that Macy's became the first retailer to deploy Shopkick's streamlined technology, which has also allowed it to expand the rewards program across the U.S. While many of Macy's competitors appear to be adopting the company's successful policies, none has yet shown the skill and awareness necessary to make the changes appealing to a wider customer base.

Putting the pieces together
Today, Macy's 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.