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 PotashCorp's (NYS: POT) recent results tell us about its potential for future gains.

What the numbers tell you
The graphs you're about to see tell PotashCorp'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 reported at a steady rate, we'll also look at how much PotashCorp'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 PotashCorp's share price has kept pace with its earnings growth, that's another good sign that its stock can move higher.

Is PotashCorp 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.

Healthy dividends are always welcome, so we'll also make sure that PotashCorp's dividend payouts are increasing, but at a level that can be sustained by its free cash flow.

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

POT Total Return Price Chart

POT Total Return Price data by YCharts

Passing Criteria

3-Year* Change 

Grade

Revenue Growth > 30%

24.1%

Fail

Improving Profit Margin

0.2%

Pass

Free Cash Flow Growth > Net Income Growth

385.9% vs. 1.4%

Pass

Improving Earnings per Share

7.9%

Pass

Stock Growth + 15% < EPS Growth

36.6% vs. 7.9%

Fail

Source: YCharts. * Period begins at end of Q2 2009.

POT Return on Equity Chart

POT Return on Equity data by YCharts

Passing Criteria

3-Year* Change

Grade

Improving Return on Equity

(32.3%)

Fail

Declining Debt to Equity

(31.9%)

Pass

Dividend Growth > 25%

530.0%

Pass

Free Cash Flow Payout Ratio < 50% 

26.5%

Pass

Source: YCharts. * Period begins at end of Q2 2009.

How we got here and where we're going
PotashCorp earns six of nine possible passing grades, and a very strong showing on dividend metrics and free cash flow growth helps the company overcome mediocre revenue and earnings gains over the past three years. It'll need to keep cash flow growing to counter what appears to be a trend toward lower profitability in the second half and beyond.

PotashCorp recently lowered its full-year profit estimates to a range below the average analyst projection, but investors took it in stride and the stock barely budged. Chinese demands that potash costs drop for the second half of the year could weigh on PotashCorp's profits -- potash-focused fertilizer competitor Mosaic (NYS: MOS) has already underperformed the analyst consensus in its latest earnings report. Analysts had already begun turning bearish on the potash producers before Mosaic's miss, as a CIBC World Markets analyst downgraded PotashCorp several months ago.

There's been a big divergence this year between potash fertilizer producers, which have had trouble moving the needle, and nitrogen-based fertilizer makers, several of which reached new highs over the summer. Despite posting much stronger free cash flow growth than its peers, its real cash flow numbers lag its net income to a far greater degree than seen in virtually every successful nitrogen fertilizer company - and its P/E ratio isn't the best in a relatively cheap sector, either. Terra Nitrogen (NYS: TNH) had single-digit P/E and price-to-free-cash-flow ratios over the summer despite a yield several times PotashCorp's, and even more recent fertilizer spinoffs Rentech Nitrogen Partners (NYS: RNF) and CVR Partners (NYS: UAN) have much stronger free cash flow relative to their net income than PotashCorp.

Many of those companies are high-yielding master limited partnerships that can take advantage of low input costs (most nitrogen fertilizer is made from cheap natural gas) and persistently high demand from the nitrogen-starved Corn Belt to pay out big yields to shareholders, while potash still has to be dug out of the ground and must compete with other fertilizers that have better pricing control. On the flip side, should natural gas prices rebound, PotashCorp would find itself in a better position than its suddenly margin-crimped peers.

Putting the pieces together
PotashCorp 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.

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Keep track of PotashCorp by adding it to your free stock Watchlist.

The article Is PotashCorp Destined for Greatness? originally appeared on Fool.com.

Fool contributor Alex Planes holds no financial position in any company mentioned here. Add him on Google+ or follow him on Twitter @TMFBiggles for more news and insights. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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