Is Altria 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 Altria (MO 0.11%) 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 Altria'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 Altria's key statistics:

MO Total Return Price data by YCharts.

Source: YCharts. *Period begins at end of Q3 2010.

MO Return on Equity (TTM) data by YCharts.

Source: YCharts. *Period begins at end of Q3 2010.

How we got here and where we're going
Altria doesn't quite come through with flying colors in its second assessment, but it has improved from last year's score by three passing grades, racking up a total five out of nine possible passing grades for 2013. Altria has been buffeted by declining U.S. smoking rates over the past few years, though revenues and profits have been gradually on the upswing as the company maintains its pricing power. However, Altria's stock growth continues to outpace the gains in its net income, which again costs it a failing grade on this test. How might Altria boost its fundamentals over the next few quarters? Let's dig a little deeper to find out.

Over the past few years, the U.S. cigarette market has contracted by as much as 4% amid regulatory menaces and anti-smoking efforts. Fool contributor Dan Caplinger notes that authorities have issued guidelines at various levels to either limit or ban smoking in many areas, and the Food and Drug Administration has also tried to force tobacco companies to disclose the precise quantities of dangerous chemicals in cigarettes. The Centers for Disease Control and Prevention also continues to mount a massive campaign to raise public awareness about the dangerous effects of smoking. Nevertheless, these efforts have produced mixed results, as the number of cigarettes Altria shipped actually rose by roughly 1.3% in the latest quarter, growth that came at the expense of competitor Reynolds American (RAI +0.00%), which reported a 4.3% decline in cigarette shipment volume.

Altria and its peers continue to raise prices on the tobacco products, which has been the first-line defense of profits against declining volumes of cigarettes sold. Altria and Reynolds have both attempted to cut operational expenses by cutting their workforces by nearly 15% and 10%, respectively. According to The Atlantic, new tobacco products applications received by the FDA have been either simply ignored or buried under red tape, which has all but forced tobacco producers to raise prices on their existing product lines. Altria, which controls more than 50% of the U.S. market, has among the best pricing power in the tobacco business due to its dominant brands. Although Altria faces rigorous U.S. laws regarding tobacco consumption, it actually benefits from lower taxes than international counterpart Philip Morris International (PM +0.43%), which has been suffering from higher excise duties in Europe, Canada, and the U.K.

Fool contributor Rupert Hargreaves notes that the FDA could deliver its judgment on menthol cigarettes at any time, which could affect Altria and Reynolds, as menthol cigarettes account for about 20% and 30% of their total sales, respectively. However, the FDA's decision could really spoil Lorillard's (LO +0.00%) future, as that company's menthol cigarettes comprise 90% of its sales volume.

The Obama administration has also proposed a new tax budget to raise cigarette taxes by another $0.94 per pack, which is likely to give Altria and domestic peers even greater headaches. It's worth noting that the European Parliament recently decided to ban the sale of menthol cigarettes after 2022. In an effort to diversify from this risk, Altria recently launched the MarkTen e-cigarette in India. It also plans to launch the MarkTen in Arizona this month, competing head-to-head with Lorillard's Blu eCig, which already controls 49% of the e-cig market in the U.S. The domestic e-cigarette market is expected to be worth a total of $1.7 billion by the end of year, a rather small slice of the tobacco pie, but one that has nevertheless grown significantly from virtually nothing not long ago.

Putting the pieces together
Today, Altria has some 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.