Is Outerwall Inc. 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 Outerwall Inc. (OUTR) 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 Outerwall'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 Outerwall's key statistics:

OUTR Total Return Price data by YCharts.

Source: YCharts.
*Period begins at end of Q1 2011.

OUTR Return on Equity (TTM) data by YCharts.

Source: YCharts.
*Period begins at end of Q1 2011.

How we got here and where we're going
We looked at Outerwall (formerly known as Coinstar) last year, and it has lost one of the passing grades it earned then to finish with a still-respectable five-of-seven score in its second assessment. Outerwall's net income growth has shot past its free cash flow growth during our three-year time frame -- however, Outerwall's nominal trailing-12-month free cash flow is actually higher than its net income, although the two numbers have drawn closer together in recent quarters. The company's skyrocketing debt-to-equity also cost it a passing grade on the test. Will Outerwall be able to reverse these minor problems and muster a perfect score when we examine it again next year? Let's dig a little deeper to find out.

Earlier this month, Outerwall exceeded Wall Street's expectations on both top and bottom lines for its first quarter, largely because of the acquisition of the ecoATM business as well as the addition of new Redbox and Coinstar kiosks. However, the company's expansion of its ecoATM device-recycling kiosk business led to a significant increase in direct operating expenses during the first quarter, and lackluster earnings guidance for the upcoming quarter suggests that the company's Redbox business could post its first ever year-over-year revenues decline. Outerwall now expects weaker box-office returns and fewer DVD titles to impact DVD rentals and revenue per Redbox machine for the near term.

Barry Rosenstein's Jana Partners, which bought 13.5% of Outerwall's shares in October 2013, has reduced its ownership stake to 4.9%. Jana Partners had pushed Outerwall to implement a major restructuring plan, which involved a change in leadership and a reduction in the workforce. Redbox President Anne Saunders left her post and the company also laid off roughly 8.5% of its workforce, with the aim of cutting operating costs by approximately $22 million next year. Outerwall also discontinued three business lines -- Rubi, Star Studio and Crisp Market -- leaving investors somewhat skeptical about the company's future growth opportunities in an era in which DVD rentals are fast being supplanted by streaming services. However, the company's board of directors announced a $350 million share repurchase program to prop up share prices and restore confidence in the future.

My fellow writer Sean Williams points out that streaming movies will probably kill Outerwall's DVD-rental business in the coming years, and industrywide trends bear out this assessment. Netflix may lead the market in content streaming, but its DVD-rental segment has also been on a steep decline. Netflix currently has 6.7 million DVD subscribers, compared to 8 million a year ago, as it has been shedding its DVD-rental subscribers in favor of streaming subscriptions. Outerwall has been investing in new ventures such as Sample It and Coinstar Exchange to offset the decline in its DVD-rental cash cow, and also expects used mobile device trade-ins to generate $7.6 billion domestically by 2018. To serve this need, the company has ambitious plans to open 2,000 ecoATMs by the end of this fiscal year.

Putting the pieces together
Today, Outerwall 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.