NEW YORK (TheStreet) -- Frontier Communications (FTR) is a great buy from the perspective of shareholder value, identified as the net of dividend yield and buyback yield that comes out around 6%. Frontier Communications also has managed to reduce its debt, and therefore its overall capital structure is significantly better than last year's.
Frontier is having a great year during 2014 from a stock price perspective. Last year, we first started to compile lists of the cheapest stocks on the S&P 500 as measured by the CAPE Ratio, which is a tool of identifying potential deep value plays. Frontier was on a list of stocks that I provided to Meb Faber for a post last September (for the list click here). I also included this list in a newsletter which can be found right here and some discussion on the merits of stock picking based on the CAPE Ratio are discussed right here.
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As 2014 has progressed, there are now even more reasons to prefer Frontier. There was a paper written not long ago, titled "Enhancing the Investment Performance of Yield-Based Strategies," by Wes Gray, a professor at Drexel and a fund manager at Empiritrage. Central findings of this research were:
High dividend yield stocks do not reliably earn above-average risk-adjusted returns. More complete measures of shareholder yield, which account for net share repurchases, perform better. We explore the use of net-debt paydown as a way to further enhance shareholder yield. The addition of net-debt paydown enhances risk-adjusted returns and creates a shareholder yield metric that is more robust over time.
While somewhat shocking to most readers, a high dividend yield is not really the best thing. The central thesis of this research paper was reiterated in the book Shareholder Value (written by Meb Faber). The argument was set forth that a strong portfolio could be created, where three items, all related to capital structure, were used for analysis
These three items were:
- dividend yield
- net buyback yield
- reduction of debt with respect to equity
The dividend yield and buyback yield are netted in order to obtain the true level of shareholder yield. The reduction in debt shows an increase of assets on a per-dollar basis against the equity or shares that an individual investor holds within the company (this can also be seen in the commonly understood price-to-book ratio).
For Frontier, we have an uncommonly high dividend yield and low share issuance, which means that the shares are not being diluted, and that the dividend yield is a much more accurate representation when compared with other companies that will issue a high dividend yield with a correspondingly increasingly high number of shares. Playing with the capital structure of a company in this manner causes a reduction in "real" shareholder value as the high dividend yield is reduced by dilution of the shares. Frontier, however, has done rather well in this regard, as one can see from the chart.
Frontier has a dividend yield of 6% and has held back from issuing additional shares. Therefore, the 6% is an accurate representation of the true yield of the company. Additionally, Frontier managed to also reduce its debt burden, which is a net positive with respect to its capital structure.
Frontier represents a strong play from the perspective of capital structure as debt plays a smaller role and the net shareholder yield is just short of 6%, which is very high for the overall market. Generally, when the dividend yield is high, we see the net buyback yield dip severely on the negative side. In this case, we see a strong combined yield that results in a strong value play for Frontier.
At the time of publication, the author held no positions in any of the stocks mentioned.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
TheStreet Ratings team rates FRONTIER COMMUNICATIONS CORP as a Buy with a ratings score of B. TheStreet Ratings Team has this to say about their recommendation:
"We rate FRONTIER COMMUNICATIONS CORP (FTR) a BUY. This is driven by some important positives, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its compelling growth in net income, good cash flow from operations, solid stock price performance, impressive record of earnings per share growth and expanding profit margins. We feel these strengths outweigh the fact that the company has had generally high debt management risk by most measures that we evaluated."
You can view the full analysis from the report here: FTR Ratings Report