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Is Frontier Communications the Perfect Stock?

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Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?

One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide if Frontier Communications (NYSE: FTR  ) fits the bill.

The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.

Some of the most basic yet important things to look for in a stock are:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
  • Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
  • Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
  • Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Frontier.


What We Want to See


Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 7.7% fail
  1-Year Revenue Growth > 12% 38.0% pass
Margins Gross Margin > 35% 83.9% pass
  Net Margin > 15% 3.8% fail
Balance Sheet Debt to Equity < 50% 155.2% fail
  Current Ratio > 1.3 0.86 fail
Opportunities Return on Equity > 15% 3.9% fail
Valuation Normalized P/E < 20 19.80 pass
Dividends Current Yield > 2% 7.9% pass
  5-Year Dividend Growth > 10% (5.6%) fail
  Total Score   4 out of 10

Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.

Frontier manages just four points on our 10-point scale. Despite having an impressive dividend yield, the rural telecom provider lacks some of the traits you'd like to see in a perfect stock.

Rural telecoms have one major thing going for them: They spit out huge gobs of cash flow, which they have then turned around and paid out to shareholders. That's the major attraction for investors in Frontier, CenturyLink (NYSE: CTL  ) , and Windstream (Nasdaq: WIN  ) , each of which has extremely high dividend yields that people want in today's low-rate environment.

The challenges come from the nature of the business. These companies lack the growth prospects you'll find elsewhere in the telecom industry. Frontier's recent growth (its revenues tripled last quarter!) has come from acquiring assets from Verizon (NYSE: VZ  ) , and despite those new holdings, analysts expect earnings to drop substantially over the next five years. That has already led to a 25% reduction in Frontier's dividend earlier this year, and further drops could come in the future.

The big question is whether consolidation brings economies of scale that improve the prospects for the industry. If so, company cash flows should improve dramatically and prove dour analyst estimates wrong. If not, then Frontier may never get much closer to becoming the perfect stock.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Click here to add Frontier Communications to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.

Read/Post Comments (1) | Recommend This Article (19)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 23, 2010, at 2:52 PM, exdividendday wrote:

    Frontier Communications Corporation is a communications company providing services to rural areas and small and medium-sized towns and cities. It provides communications services to residential and business customers and offers a variety of voice, data, Internet, and television services that are available as bundled or packaged solutions and for some products. In your peer, FTR is not the cheapest stock. Price to earnings ratio amounts to 33.10 (rank 3) and price to book ratio is 8.90 (rank 3). Finally, in price to sales ratio, FTR has the most expensive ratio of 4.38. This is somewhat surprising because the company has the worst margin situation (net profit margin of 5.82 percent) and the worst debt to assets ratio (69.80). The best value is reached in dividend yield (8.03 percent). I researched some more telecom service stocks that could be more interesting. Here is a table of 14 high yielding telecom services stocks with some fundamentals:

    The average dividend-yield of my list amounts to 5.94 percent while the average P/E ratio is 35.75.

    Buy CTL or VZ!

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