Stock Smackdown: Which High-Yielding Telecom Could You Buy Today?

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Welcome to "Stock Smackdown," where two of your favorite stocks go head to head in a battle for superiority. They'll each be judged on a series of objective merits, including valuation, earnings quality, price appreciation, and dividend quality. We'll also take a look ahead at some more subjective measures. Wall Street's analysts will get their say, but so will The Motley Fool's top market minds.

The winner will be the stock that racks up the most points at the end of their competition. Let's go to ringside and meet our two combatants, Telefonica (NYS: TEF) and Frontier Communications (NYS: FTR) .

In this corner...
Hefty dividends ahead! Investors love both of these stocks for their big, big yields, but neither payout is a sure thing.


Telefonica's big risk arises from its Spanish base of operations. If you've managed to completely avoid international news, Spain might be the European country with the greatest downside. Unemployment levels in the country are nothing less than a national catastrophe, and since Spain's economy is much larger than Greece's, it poses a bigger risk to both the companies within it and the countries that have supported it in the eurozone. However, much of Telefonica's revenue comes from Latin America, which could help it weather the economic hurricanes in Spain.

Frontier's dividend has actually been on the decline in recent years. The rural-America-focused telecom finally (according to management, at least) digested the chunk of Verizon's (NYS: VZ) landline assets it bought in 2010, which might herald better days ahead. Of course, the possibility also exists that rural America might not be the best target market for long-term growth. Time will tell if Frontier's former Verizon assets truly turn out to be assets, rather than the liabilities they've appeared since the acquisition.

Valuation battle
We use many different numbers and ratios when talking about the value of a stock. The price-to-earnings ratio is the standard, so we'll check each company's current P/E and five-year historical average P/E. We'll also use price to free cash flow today. Earnings can be gamed with a number of different accounting tricks, but free cash flow is harder to manipulate, making it a favored metric here at the Fool.

In each case, the difference between a stock's current ratio and its five-year average ratio will be more important than the numbers themselves. Stocks trading significantly lower than their average ratios may have more room to return to that middle ground.

For the tiebreaker, we'll check one less-used financial metric: the debt-to-equity ratio. A company with little or no debt is usually in better shape than one leveraged to its eyeballs.

Metric

Telefonica

Frontier

P/E9.932.0
5-Year Average P/E8.920.4
P/FCF1.52.8
5-Year Average P/FCF2.75.8
Debt/Equity2.61.7

Source: Wolfram Alpha and Morningstar. Winners in bold.

It looks like Telefonica takes this round, despite Frontier's strong comeback effort at the end. How will Telefonica fare in the next? Let's find out.

Earnings quality battle
A company can be cheaply valued without being a good value. To balance out our valuation fight, let's look at a few key earnings statistics for each company. We'll look at gross and net margins, a five-year annualized rate of earnings growth, and consecutive years of both positive earnings and earnings growth since 1992, two decades ago. A company with no momentum today is less likely to become a superstar later -- it has happened before, but not often.

Metric

Telefonica

Frontier

Gross Margin71.6%87.9%
Net Margin7%2.4%
5-Year Annualized Earnings Growth(12.6%)(9.9%)
Consecutive Profitable Years (since 1992)99
Consecutive Years of Earnings Growth00

Sources: Morningstar. Winners in bold.

Frontier takes the earnings quality crown, in one ugly battle. Can Frontier fend off Telefonica in the dividend battle ahead?

Dividend battle
A growing company is great, but one that pays you back is even better. Since both companies are paying dividends today, let's see how strong and stable they really are. We'll examine yield, the earnings and free cash flow payout ratios, the five-year annualized dividend growth rate, and each company's current streak of uninterrupted payments.

Those payout ratios are important, particularly the free cash flow payout ratio. Companies that pay out more than they take in can rarely sustain such practices for long.

Metric

Telefonica

Frontier

Dividend Yield12.4%14.7%
Payout Ratio167.1%541%
Free Cash Flow Payout Ratio90.1%109.8%
5-Year Annualized Dividend Growth13.6%(10.3%)
Years of Uninterrupted Dividends2421

Sources: Morningstar and Dividata. Winners in bold.

This one isn't close. Despite Frontier's higher yield, Telefonica is the clear dividend champion, thanks to stronger growth and a more sustainable payout. Can it survive the final round?

Battle for the investors
Looking at the past is well and good, but let's go further. How do the world's most engaged market participants view these companies? Let's see what Wall Street's analysts expect from these companies, and what our Motley Fool CAPS community thinks.

Metric

Telefonica

Frontier

"Buy" Recs (% of Total Ratings)38.1%44.4%
Average Upside Potential32.1%23%
CAPS Sentiment (% Outperform)97.3%90.6%

Sources: Marketwatch and Motley Fool CAPS.

After four rounds, Telefonica has sealed the deal, taking three rounds to Frontier's lone win. However, it's still very important to pay attention to what each company's plans are for the months and years ahead.

Battle for the future
Telefonica's biggest news-making initiative lately was the revelation that it's planning to develop an open-source operating system with Mozilla, the nonprofit foundation behind the Firefox browser. The Firefox Mobile OS also has chipmaker Qualcomm and global communications-hardware maker Alcatel-Lucent (NYS: ALU) onboard, which sends the signal that this could be a seriously ambitious shakeup in the crowded mobile space.

That ambitious partnership hasn't yet changed Nomura's analysts' minds. Their sell rating still stands for Telefonica, which is a bit of a slap in the face to stockholders, since the analysts at Nomura recently gave the green light to similarly woebegone Euro-carrier France Telecom (NYS: FTE) . Telefonica hasn't helped its case with a recent dividend cut, but you can still make the case that its payouts have held up better than Frontier's.

Foolish telecom specialist Dan Radovsky has pointed out that Frontier's recently resorted to some dodgy cash-flow accounting to make its already-weakened dividend payouts look more sustainable. Don't worry about my calculations, though -- Morningstar contains the accurate figures in their proper places. That doesn't excuse Frontier. Gaming the numbers is always a big red flag.

Frontier's also been realigning itself toward rural landline service at the expense of other offerings. The company made its high-speed Internet offerings as onerous as possible last year. Its answer to the wireless revolution was to become an AT&T reseller. The Verizon assets are really Frontier's last, best hope, and I just can't see a situation where a rural telecom beats an international provider, even if part of the "international" happens to be in a country spiraling the drain.

Neither company is perfect, not by a long shot. Still, Telefonica is without a doubt the better option of these two high-yielding telecoms. Do you agree? Disagree? Feel free to share your opinion with a comment below.

Don't get tunnel vision on dividends. There are many great stocks on the market that might not have double-digit yields, but they've got the strength and stability to grow in any economic climate. Find out more about some of the market's best stocks in our most popular free report on how you can "Secure Your Future With 9 Rock-Solid Dividend Stocks."

The article Stock Smackdown: Which High-Yielding Telecom Could You Buy Today? originally appeared on Fool.com.

Fool contributor Alex Planes holds no financial position in any company mentioned here. Add him on Google+ or follow him on Twitter @TMFBiggles for more news and insights.The Motley Fool owns shares of Qualcomm and France Telecom. Motley Fool newsletter services have recommended buying shares of France Telecom. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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