Is ZAGG 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 ZAGG (NASDAQ: ZAGG  ) 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 ZAGG'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 ZAGG's key statistics:

ZAGG Total Return Price data by YCharts

Passing Criteria

3-Year* Change

Grade

Revenue growth > 30%	311.8%	Pass
Improving profit margin	(74.9%)	Fail
Free cash flow growth > Net income growth	48,060% vs. 3.2%	Pass
Improving EPS	(19.5%)	Fail
Stock growth (+ 15%) < EPS growth	(12.3%) vs. (19.5%)	Fail

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

ZAGG Return on Equity (TTM) data by YCharts

Passing Criteria

3-Year* Change

Grade

Improving return on equity	(86.4%)	Fail
Declining debt to equity	15,250%	Fail

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

How we got here and where we're going
Things don't look good for ZAGG in its second assessment, as the accessories manufacturer dropped two of the four passing grades it scored last year to finish with a middling two out of seven passing grades. It's been a rough year for ZAGG, as the company's stock has shed 46% of its value in 2013, a decline only accentuated by the departure of CEO Robert Pedersen. ZAGG has been facing fierce competition from other third-party accessories suppliers, which has resulted in serious margin compression over the past few years. Can ZAGG turn it around, or is this company's future not all it's cracked up to be?

ZAGG's coming off a rather miserable stretch of weakness. The company had to  reduce its guidance twice over the summer and let down investors who were anticipating a rebound by posting a whopping 17% decline in sales for its latest quarter. Longtime Fool Rick Munarriz notes that Apple (NASDAQ: AAPL  ) has been increasingly banking on its own accessories, which has combined with a tighter third-party field of competition to crowd out ZAGG's formerly snug position. Apple, whose accessories market is estimated to be worth around $2 billion, has sought out tighter control of these secondary products as a way to generate add-on revenues. However, ZAGG might benefit from Apple's rumored curved-screen iPhone next year, as customers are likely to need some highly customized defenses and other accessories to fit the unusual shape.

Over the past few quarters, the company has been trying to diversify away from its traditional offerings (primarily the invisibleSHIELD), which accounts for nearly half of ZAGG's sales. ZAGG launched a keyboard called "Caliber Advantage," which adds traditional gamepad controls to Apple's iPhone, earlier this year. According to NPD Group, physical game spending fell by 21% in 2012, while digital content spending improved nearly 16% -- a trend clearly illustrating the shift toward gaming on mobile devices, which ZAGG could now begin to capitalize on.

On the other hand, ZAGG's also faced significant headwinds because of the perception that its offerings are commoditized or simply irrelevant. Fool contributor Rex Moore notes that Corning's (NYSE: GLW  ) ever advancements in Gorilla Glass, undermine ZAGG's protective-screen business by essentially catering to the same problem. Furthermore, ZAGG's move into the audio accessories market, which is largely dominated by Skullcandy (NASDAQ: SKUL  ) , couldn't drive much sales growth as the company has to face Skullcandy's discounts -- the headphones segment is becoming highly commoditized, with relatively few exceptions. The mobile-computing accessories market is expected to grow to $60 billion by 2015, but in order to grab a larger slice of that pie, ZAGG will have to find the killer edge that will differentiate it in a tightly packed field.

Putting the pieces together
Today, ZAGG has few 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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