Is Frontier Communications the Right Stock to Retire With?

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Now more than ever, a comfortable retirement depends on secure, stable investments. Unfortunately, the right stocks for retirement won't just fall into your lap. In this series, I look at 10 measures to show what makes a great retirement-oriented stock.

If dividends were the only measure of a stock, then Frontier Communications (NYS: FTR) would be near the top of the list. The rural telecom's yield has recently risen to nearly 15%, thanks largely to the company's huge cash flows, which dwarf its GAAP profitability. But apart from those payouts, does Frontier have what conservative investors need for their retirement portfolios? Below, we'll look at how the company does on our 10-point scale.

The right stocks for retirees
With decades to go before you need to tap your investments, you can take greater risks, weighing the chance of big losses against the potential for mind-blowing returns. But as retirement approaches, you no longer have the luxury of waiting out a downturn.

Sure, you still want good returns, but you also need to manage your risk and protect yourself against bear markets, which can maul your finances at the worst possible time. The right stocks combine both of these elements in a single investment.

When scrutinizing a stock, retirees should look for:

  • Size. Most retirees would rather not take a flyer on unproven businesses. Bigger companies may lack their smaller counterparts' growth potential, but they do offer greater security.
  • Consistency. While many investors look for fast-growing companies, conservative investors want to see steady, consistent gains in revenue, free cash flow, and other key metrics. Slow growth won't make headlines, but it will help prevent the kind of ugly surprises that suddenly torpedo a stock's share price.
  • Stock stability. Conservative retirement investors prefer investments that move less dramatically than typical stocks, and they particularly want to avoid big losses. These investments will give up some gains during bull markets, but they won't fall as far or as fast during bear markets. Beta measures volatility, but we also want a track record of solid performance as well.
  • Valuation. No one can afford to pay too much for a stock, even if its prospects are good. Using normalized earnings multiples helps smooth out one-time effects, giving you a longer-term context.
  • Dividends. Most of all, retirees look for stocks that can provide income through dividends. Retirees want healthy payouts now and consistent dividend growth over time -- as long as it doesn't jeopardize the company's financial health.

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

Factor

What We Want to See

Actual

Pass or Fail?

SizeMarket cap > $10 billion$5.11 billionFail
ConsistencyRevenue growth > 0% in at least four of past five years4 yearsPass
 Free cash flow growth > 0% in at least four of past five years2 yearsFail
Stock stabilityBeta < 0.90.77Pass
 Worst loss in past five years no greater than 20%(36.8%)Fail
ValuationNormalized P/E < 1821.06Fail
DividendsCurrent yield > 2%14.6%Pass
 5-year dividend growth > 10%(5.6%)Fail
 Streak of dividend increases >= 10 years0 yearsFail
 Payout ratio < 75%486.5%Fail
    
 Total score 3 out of 10

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

With only three points, Frontier Communications doesn't give conservative investors the full slate of reliable characteristics they prefer to see. You can't argue with the stock's dividend payout, but apart from that, Frontier has some big questions to answer.

Companies that provide basic telephone services to rural areas may seem like the least likely area for an interesting investment. But lately, the rural telecom industry has seen serious growth, driven largely by acquisitions. Frontier bought a big chunk of legacy customers from Verizon (NYS: VZ) , while CenturyLink (NYS: CTL) bought Qwest Communications, and Windstream (NAS: WIN) recently closed on its deal with PAETEC.

But Frontier hasn't been content to settle for landline business alone. Rather than ceding low-end mobile services to second-tier carriers like Leap Wireless (NAS: LEAP) and MetroPCS (NYS: PCS) , Frontier recently announced a three-year deal to act as a reseller for AT&T (NYS: T) wireless services.

Still, not everything has gone smoothly for Frontier. The company is losing customers because of the nature of the landline business, although its broadband services have shown reasonable growth.

For retirees and other conservative investors, Frontier's 25% dividend cut last year raised questions about whether it would simply be the first cut among many. Although its earnings-based payout ratio of 486.5% doesn't reflect its actual cash flow, Frontier is paying near 100% on a free-cash-flow basis. A 14.5% yield may sound nice, but you may prefer something more modest and sustainable for your low-risk retirement portfolio.

Keep searching
Finding exactly the right stock to retire with is a tough task, but it's not impossible. Searching for the best candidates will help improve your investing skills, and teach you how to separate the right stocks from the risky ones.

Add Frontier Communications to My Watchlist, which will aggregate our Foolish analysis on it and all your other stocks.

If you want to retire rich, you need to be confident that you've got the basics of your investment strategy down pat. See if you're on track by following the "13 Steps to Investing Foolishly."

At the time this article was published 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.

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