Has Level 3 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 Level 3 Communications (NYSE: LVLT  ) 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 Level 3 Communications.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

8.4%

Fail

 

1-year revenue growth > 12%

47.1%

Pass

Margins

Gross margin > 35%

59.2%

Pass

 

Net margin > 15%

(6.6%)

Fail

Balance sheet

Debt to equity < 50%

750.5%

Fail

 

Current ratio > 1.3

1.02

Fail

Opportunities

Return on equity > 15%

(35.7%)

Fail

Valuation

Normalized P/E < 20

NM

NM

Dividends

Current yield > 2%

0%

Fail

 

5-year dividend growth > 10%

0%

Fail

       
 

Total score

 

2 out of 9

Source: S&P Capital IQ. NM = not meaningful due to negative earnings. Total score = number of passes.

Since we looked at Level 3 Communications last year, the company hasn't been able to improve on its two-point score, as it has remained unprofitable. The stock has performed badly, falling nearly 20% over the past year.

With its dual focus on operating a fiber-optic network and acting as an Internet content-delivery service, Level 3 has suffered from big challenges on both sides of its business. Despite offering high-speed service, its network hasn't generated the cash flow that wireless network providers AT&T and Verizon have managed to produce. Meanwhile, on the content side, the decision that partner Netflix (NASDAQ: NFLX  ) made to move its traffic management in-house will cut the revenue Level 3 has received from its arrangement with the streaming video company.

In its most recent quarter, Level 3 disappointed investors with a weak earnings report. Although the company saw revenue rise slightly and said that its balance sheet has gotten stronger over the past year, Level 3 still posted a substantial loss for the fourth quarter. Expectations for seasonally weak sales in the current quarter also held back the stock.

The big hope for Level 3 is that a big acquirer might decide to buy out the company. With Google delivering high-speed service via its fiber-network experiment, Level 3's network might become more relevant. Yet with so much debt, Level 3's $12 billion enterprise value may prove a bit high for potential buyers despite arguably offering reasonable value.

For Level 3 to improve, it needs to find better sources of profitable sales. Unless it can do so, Level 3 is doomed to remain far from perfection for the foreseeable future.

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.

Moves like developing its own in-house traffic-management system have helped Netflix regain its momentum lately, but can Netflix keep up its new growth pace? Find out in our premium research report on Netflix, in which you'll learn about the key opportunities and risks facing the company, as well as reasons to buy or sell the stock. We're also offering a full year of updates as key news hits, so make sure to click here and claim a copy today.

Click here to add Level 3 Communications to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.


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