Does Frontier Communications Corp (FTR) Pass Buffett’s Test?

Frontier Communications Corp (NASDAQ:FTR) is in a tough spot due to its heavy reliance on the dying rural landline business. The company’s acquisition of Verizon Communications Inc. (NYSE:VZ)’s landline business may have made the company’s numbers look better by immediately increasing its revenues and size. However, it also forced Frontier to take on a huge load of debt and improved Verizon Communications Inc. (NYSE:VZ)’s position by giving it the cash to grow its wireless network more quickly.

In addition, Frontier Communications Corp (NASDAQ:FTR) has had limited success signing up customers for higher-margin services, such as its broadband services. In contrast, CenturyLink’s involvement in cloud computing offers some promise of growth in high-margin product sales in the future, and Windstream’s revenues are increasing.

The cash king margin can help you find highly profitable businesses, but it should only be the start of your search. The ratio does have its limits, especially for fast-growing small businesses. Many such companies reinvest all of their cash flow into growing the business, leaving them little or no free cash — but that doesn’t necessarily make them poor investments. Conversely, the formula works better for slower-growing blue chips. You’ll need to look closer to determine exactly how a company is using its cash.

Still, if you can cut through the earnings headlines to follow the cash instead, you might be on the path toward seriously great investments.

Businesses with consistently high ROIC show that they’re efficiently using capital. They also have the ability to treat shareholders well, because they can then use their extra cash to pay out dividends to us, buy back shares, or further invest in their franchise. And healthy and growing dividends are something that Warren Buffett has long loved.

The article Does Frontier Communications Pass Buffett’s Test? originally appeared on Fool.com and is written by Jim Royal.

Jim Royal has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

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