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Is Verizon Communications Inc. (VZ) Destined for Greatness?

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Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Verizon Communications Inc. (NYSE:VZ) fit the bill? Let’s take a look at what its recent results tell us about its potential for future gains.

Verizon Communications Inc. (NYSE:VZ)What we’re looking for
The graphs you’re about to see tell Verizon Communications Inc. (NYSE:VZ)’s story, and we’ll be grading the quality of that story in several ways:

  • Growth: Are profits, margins, and free cash flow all increasing?
  • Valuation: Is share price growing in line with earnings per share?
  • Opportunities: Is return on equity increasing while debt to equity declines?
  • Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let’s take a look at Verizon Communications Inc. (NYSE:VZ)’s key statistics:

VZ Total Return Price Chart

VZ Total Return Price data by YCharts

Passing Criteria 3-Year* Change Grade
Revenue growth > 30% 8.2% Fail
Improving profit margin (71.4%) Fail
Free cash flow growth > Net income growth (16%) vs. (69.1%) Pass
Improving EPS (69%) Fail
Stock growth (+ 15%) < EPS growth 109.4% vs. (69%) Fail

Source: YCharts. * Period begins at end of Q1 2010.

VZ Return on Equity Chart

VZ Return on Equity data by YCharts

Passing Criteria 3-Year* Change Grade
Improving return on equity (63.6%) Fail
Declining debt to equity 4.4% Fail
Dividend growth > 25% 8.4% Fail
Free cash flow payout ratio < 50% 107.1% Fail

Source: YCharts. * Period begins at end of Q1 2010.

How we got here and where we’re going
Things seem to be pretty ugly for Verizon Communications Inc. (NYSE:VZ) today. The broadband and telecommunication services provider earns only one out of nine possible passing grades, and even that lone pass was granted more on the fact that free cash flow is suffering a less ugly decline than net income. Verizon Communications Inc. (NYSE:VZ)’s trailing 12-month free cash flow may actually be over 11 times higher than its net income, but the company’s still paying out a worryingly high amount of that cash flow as dividends. Despite several weaknesses, Verizon Communications Inc. (NYSE:VZ)’s shares have been pushed steadily higher for the past three years. Can Verizon keep rewarding shareholders this well in the future? Let’s dig a little deeper to find out.

Verizon recently finished the roll-out of its 4G LTE network, which now covers 500 markets, and more than 99% of Verizon’s 3G service area. AT&T Inc. (NYSE:T), which is still behind Verizon in terms of coverage, recently added another 35 LTE markets to reach a total of 326 markets, and now covers 292 million people on its 4G network. However, AT&T Inc. (NYSE:T) also includes HSPA+ in its 4G marketing claims, and actual connection speeds may not justify that assertion under typical 4G definitions. Smaller carriers Sprint and T-Mobile are still far behind in the LTE race. Verizon has enough financial strength to continue to lead telecommunications companies into the next generation of service.

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