Investors often use return on equity as a quick way to judge the overall quality of a company. After all, the more profit a company churns out on a given amount of equity, the more of the green stuff it can pile up for its investors.
Over the past three years, Frontier Communications
DuPont analysis breaks down ROE into three parts: profit margin, asset turnover, and leverage. This allows investors to pinpoint exactly how a company is generating its returns.
Let's take a look at how Frontier has been drumming up its extra returns.
2007 |
2008 |
2009 |
Last 12 Months |
|
---|---|---|---|---|
Net Income Margin |
9.4% |
8.2% |
5.7% |
6.4% |
Asset Turnover |
0.3x |
0.3x |
0.3x |
0.3x |
Leverage |
7.3x |
13.3x |
21x |
26x |
Source: Capital IQ, a Standard & Poor's company, and author's calculations.
This is the outcome we'd least like to see. While overall ROE has increased, margins have fallen, and asset efficiency has stayed flat while the company has become much more levered. And as far as leverage goes, it's not going away any time soon. The company is assuming $3.5 billion in debt thanks to its deal with Verizon
Of course we don't want to just look at Frontier in a vacuum. Here's a look at how the company stacks up against some comparable companies.
Company |
Net Income Margin |
Asset Turnover |
Leverage |
ROE |
---|---|---|---|---|
Frontier |
6.4% |
0.3x |
26x |
50% |
CenturyLink |
13.8% |
0.5x |
2.3x |
15.9% |
Windstream |
9.5% |
0.4x |
15.7x |
59.7% |
Source: Capital IQ, a Standard & Poor's company, and author's calculations.
Data is for last 12-month period.
ROE is return on ending equity.
Though CenturyLink has opted to not jack its leverage sky high, it appears that using liberal leverage is far from unheard of among regional telecom companies. In fact, Qwest Communications
It's obvious that these companies are trying to make the best of a bad situation -- regional wireline telecom services are under heavy attack, but this group is hoping to use the reliability of the remaining business to squeeze out more for equity holders through higher leverage.
Dividend investors have been drawn to this sector like bees to honey thanks to generous dividend payouts, but excited yield-snatchers would be well advised to keep an eye on the risk these companies are taking on.
When it comes to dividends, I prefer this rock-solid play.