Verizon's Story - Worth Your Money?

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In a previous post, I wrote about the fact that everything and everyone, including corporations, have a story.  I then went on to say that stories are typically multifaceted, and every one story has a number of contributing smaller stories, which come together to tell that greater story.  And, as a geeky accountant, I find it exciting that ingrained within every company’s greater story is the story of its financial statements.

In this post, I want to highlight a few plots within the financial narratives of Verizon Communications, Inc. (NYSE: VZ), two of its competitors, AT&T, Inc. (NYSE: T) and Sprint Nextel Corp (NYSE: S), and the Domestic Telecom Services industry in general.  Maybe you’ve already decided on which provider is best for your cellular needs, but which one’s financials (if any) tell the best investment-worthy story?  That’s the decision I’d like to help you make.

Specifically, we'll take a look at revenue growth and gross margins to see how successful the companies have been at not only generating revenue, but also at managing the corresponding costs to do so.  We'll also evaluate each company's debt to equity ratio to see how financially stable they are, and their return on equity to see if they’re adding value to shareholders.  Lastly, we’ll look at their price to earnings and price to free cash flow ratios to see how well they're priced.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p><strong>VZ</strong></p> </td> <td> <p><strong>T</strong></p> </td> <td> <p><strong>S</strong></p> </td> <td> <p><strong>INDUSTRY</strong></p> </td> </tr> <tr> <td> <p>Rev. Growth (5 Yr. Avg.)*</p> </td> <td> <p>4.23%</p> </td> <td> <p>3.48%</p> </td> <td> <p>-3.63%</p> </td> <td> <p>9.16%</p> </td> </tr> <tr> <td> <p>Gross Margin (5 Yr. Avg.)*</p> </td> <td> <p>59.10%</p> </td> <td> <p>58.50%</p> </td> <td> <p>50.20%</p> </td> <td> <p>60.60%</p> </td> </tr> <tr> <td> <p>Debt to Equity (MRQ)*</p> </td> <td> <p>1.41</p> </td> <td> <p>0.62</p> </td> <td> <p>2.30</p> </td> <td> <p>0.89</p> </td> </tr> <tr> <td> <p>Return on Equity (TTM)*</p> </td> <td> <p>7.70%</p> </td> <td> <p>4.40%</p> </td> <td> <p>N/A</p> </td> <td> <p>N/A</p> </td> </tr> <tr> <td> <p>Price/Earnings (TTM)*</p> </td> <td> <p>46.10</p> </td> <td> <p>50.90</p> </td> <td> <p>N/A</p> </td> <td> <p>19.20</p> </td> </tr> <tr> <td> <p>Price/Free Cash Flow (TTM)*</p> </td> <td> <p>18.90</p> </td> <td> <p>62.40</p> </td> <td> <p>311.70</p> </td> <td> <p>34.80</p> </td> </tr> </tbody> </table>

*Data obtained from fool.com

The Verizon Story

As you can see from the above chart, the Verizon story (or at least the financial performance chapter) is mediocre at best.  Verizon managed to achieve a less-than-impressive five-year average revenue growth of only 4.23%, but it did so with a pretty decent five-year average gross margin of 59.10%.  While Verizon’s revenue growth is certainly above that of AT&T’s and Sprint’s (which is negative—ouch!), it’s more than two times less that of its industry.

Additionally, while Verizon’s debt to equity isn’t awful, it is still worse than AT&T’s and the industry average.  It’s worth mentioning though that Verizon issued a decent amount of long-term debt in the most recent year, however it has made an effort in the past two quarters to pay that debt down.

The best part, though, of the Verizon story (and perhaps the only good part) is its return on equity, but even this is not great.  It has generated a decent trailing twelve-month return on equity of 7.70%, which is definitely better than AT&T’s 4.40%, but it’s nothing to write home about.

Based on the narrative thus far, I would hope and expect to see Verizon’s price at a discount, which is exactly what we see here.  Although its 46.10 P/E isn’t necessarily all that appealing, being over twice the industry’s 19.20 P/E, its 18.90 P/FCF (which is a much better valuation ratio) is significantly less than its competitors’ and industry.  At surface level, this indicates an undervalued stock, but the ultimate question is, "Is it undervalued for a reason?"

Good, but Not Good Enough

Based on a quick, high-level analysis of Verizon’s financial narrative and that of its competitors, I’d say it’s definitely the better story.  However, it’s clear that the somewhat cheap P/FCF is due to subpar revenue growth and mediocre returns, and therefore may not be worth your investment bookshelf after all.  Again, the financial stories of these companies are only a small part of the greater story, and much more research and analysis are necessary to form an investment decision, but for now I’ll hold off on adding this one to my collection.


mattmcmichen has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. 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 Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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