Has Frontier Communications Become the Perfect Stock?

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 Frontier Communications (NASDAQ: FTR  ) 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 Frontier Communications.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

18%

Pass

 

1-year revenue growth > 12%

(4.8%)

Fail

Margins

Gross margin > 35%

90.8%

Pass

 

Net margin > 15%

3%

Fail

Balance sheet

Debt to equity < 50%

205.7%

Fail

 

Current ratio > 1.3

1.40

Pass

Opportunities

Return on equity > 15%

3.7%

Fail

Valuation

Normalized P/E < 20

16.89

Pass

Dividends

Current yield > 2%

8.9%

Pass

 

5-year dividend growth > 10%

(13.4%)

Fail

       
 

Total score

 

5 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Frontier Communications last year, the company has held onto the point it gained from 2011 to 2012. But revenue contracted even as Frontier's current ratio improved, and the share price has fallen by about another 10% over the past year.

Frontier investors face a big dilemma. On one hand, the stock's dividend yield is truly impressive. Yet at its core, much of Frontier's revenue comes from a failing rural landline business, and despite efforts to try to push customers into higher-margin, more modern services like broadband, Frontier's falling sales point to a lack of complete success on that score.

Moreover, Frontier's competitors have taken better steps toward building a sustainable business. Windstream (NASDAQ: WIN  ) has a high enough dividend yield to raise some of the same concerns as Frontier, but Windstream has managed to grow its revenue and has an arguably stronger strategy for diversifying into more profitable service offerings. CenturyLink (NYSE: CTL  ) has taken a big step toward making a bigger footprint in the cloud computing space, with its 2011 acquisition of SAVVIS giving it exposure that it never had before to the cloud.

Frontier recently decided to take the somewhat odd step of providing electricity and natural gas in Ohio. The move admittedly gives it diversification, but in a direction that seems to take it away from its core competency.

For Frontier to improve, it needs to identify growth opportunities and execute on them to help get revenue moving in the right direction. Otherwise, further dividend cuts may prove necessary, and the stock may never get any closer to perfection.

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.

While Frontier's its juicy dividend is tempting, every Frontier investor has to understand that it's not a sure thing. A huge acquisition has transformed the company forever. Will the move bear fruit, or are investors destined for another disappointing dividend cut? In this premium research report on Frontier Communications, we walk you through all of the key opportunities and threats facing the company. Better yet, you'll receive a full year of updates to boot. Click here to learn more.

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


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