Is Level 3 Communications Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Level 3 Communications (LVLT) fit the bill? Let's look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Level 3 Communications' story, and we'll be grading the quality of that story in several ways:

• Growth: Are profits, margins, and free cash flow all increasing?
• Valuation: Is share price growing in line with earnings per share?
• Opportunities: Is return on equity increasing while debt to equity declines?
• Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Level 3 Communications' key statistics:

LVLT Total Return Price data by YCharts

Source: YCharts.
*Period begins at end of Q3 2010.

LVLT Return on Equity (TTM) data by YCharts

Source: YCharts.
*Period begins at end of Q3 2010.

How we got here and where we're going
We looked at Level 3 last year, and it has lost one passing grade in its second assessment to finish up with a mediocre score of four out of seven possible passing grades for 2013. Over the past few years, Level 3 has been able to push its net margins and free cash flow levels higher -- however, both still remain in negative territory. Level 3's stock has also outpace the gains in its net income, which could be problematic should investor perceptions cool. Is the company's 2013 share-price rebound sustainable, or will the networking services specialist be brought low by fundamental weaknesses? Let's dig a little deeper to find out.

Level 3 has long been plagued by a mountain of debt and redundant operations, which contributed to lackluster third-quarter results. However, the company has managed to slash its losses by more than 85%, regardless of slumping sales, in its wholesale voice-services segment. Fool contributor Dan Caplinger notes that the company's core network-services business started exhibiting some signs of improvement after struggling to overcome declining telecom-industry capital expenditures throughout the telecom industry. However, longtime Fool contributor Selena Maranjian notes that Level 3 has been expanding its video broadcasting services around the world, which could allow it to benefit from increasing high-bandwidth traffic in developing nations. Earlier this year, the company bagged a contract to manage the Virtual Private Network for the NATO-Russia Council Cooperative Airspace Initiative.

Over the past few quarters, Level 3 has faced strong competition from both Akamai Technologies (AKAM 0.33%) and Limelight Networks (EGIO 3.42%) in the content-delivery segment, which produced a bit of a price war among content-delivery services. Netflix's (NFLX 0.43%) launch of its in-house content delivery network earlier this year was a significant impediment to the trio's sales, as Netflix alone accounts for a substantial chunk of Web traffic. SBC Contract Services has also started moving its Internet traffic to AT&T's network, further impacting Level 3's wholesale voice services business.

Even Amazon.com's (NASDAQ: AMZN) expansion of its one-stop turnkey solutions for cloud-services companies are likely to siphon off content-delivery revenues as popular games, sites, and media networks shift their operations to Amazon servers. Verizon has also completed its acquisition of EdgeCast Networks, which could pose significant threats on the content-delivery market with Verizon's deep pockets in the mix. It will be interesting to see how Level 3 might overturn its sagging fortunes in the middle of this turmoil, and while coping with executive upheaval as a result of its CEO change (COO Jeff Storey was promoted to CEO this summer). He'll have to grapple with some rather unpleasant fiscal realities: Level 3's $8 billion net debt, and its persistently negative FCF, will hinder its long-term growth rates, which are presently expected to be less than 4%.

Putting the pieces together
Today, Level 3 Communications has some of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.