Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?
One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if CenturyLink (NYSE: CTL ) fits the bill.
The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:
- 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 mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
- Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
- Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
- Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
- Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. 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 CenturyLink.
What We Want to See
Pass or Fail?
|Growth||5-Year Annual Revenue Growth > 15%||49.0%||Pass|
|1-Year Revenue Growth > 12%||93.%||Pass|
|Margins||Gross Margin > 35%||60.6%||Pass|
|Net Margin > 15%||2.8%||Fail|
|Balance Sheet||Debt to Equity < 50%||106.3%||Fail|
|Current Ratio > 1.3||0.74||Fail|
|Opportunities||Return on Equity > 15%||2.5%||Fail|
|Valuation||Normalized P/E < 20||30.35||Fail|
|Dividends||Current Yield > 2%||7.3%||Pass|
|5-Year Dividend Growth > 10%||62.6%||Pass|
|Total Score||5 out of 10|
Source: S&P Capital IQ. Total score = number of passes.
Since we looked at CenturyLink last year, the company fell back by a point. The stock was up about 25% over the past year, but earnings haven't kept pace, pushing the company's normalized valuation up significantly.
CenturyLink is the biggest player in the rural telecom space, beating out rivals Frontier Communications (Nasdaq: FTR ) and Windstream (Nasdaq: WIN ) by a wide margin. CenturyLink has also done a better job of avoiding the landmines that its peers have set off, as both Windstream and Frontier have lost ground recently.
Part of what sets CenturyLink apart is its ability to keep expanding even in the face of difficult trends among telecom customers. While Frontier has had to deal with large numbers of customer defections, CenturyLink's acquisitions of Embarq, Qwest, and SAVVIS over the past few years have helped it expand its coverage area, lower landline cancellation rates, and even introduce new services. SAVVIS introduced CenturyLink to the enterprise cloud computing industry.
Although earnings are an important measure for any stock, cash flow is a better indicator of telecom success. Just as industry giants AT&T (NYSE: T ) and Verizon (NYSE: VZ ) look much healthier when you examine their cash flows, CenturyLink looks expensive on a P/E basis but appears to be in much better shape when you look at cash flow.
For CenturyLink to improve, it needs to avoid the dividend cuts that Frontier has had to make and instead use its core rural telecom business as a starting point for future expansion. That's the best chance CenturyLink has to become a perfect stock in the future.
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.
CenturyLink has promise, but does Frontier Communications have more room to run after its big decline? Decide for yourself after reading the Fool's premium report on Frontier, where you'll find valuable answers to your most pressing questions about rural telecoms. Click here to get started.
Click here to add CenturyLink to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.