Vonage Holdings Corp. (NYSE:VG) and Level 3 Communications, Inc. (NYSE:LVLT) are the two most active stocks in the Diversified Communication Services industry based on today’s trading volumes. The market is clearly enthusiastic about both these stocks, but which is the better investment? To answer this, we will compare the two companies based on the strength of their growth, profitability, risk, returns, valuation, analyst recommendations, and insider trends.
The ability to grow earnings at a compound rate over time is a crucial determinant of investment value. Analysts expect VG to grow earnings at a 10.00% annual rate over the next 5 years. Comparatively, LVLT is expected to grow at a 3.10% annual rate. All else equal, VG’s higher growth rate would imply a greater potential for capital appreciation.
Profitability and Returns
Growth doesn’t mean much if it comes at the cost of weak profitability. To adjust for differences in capital structure we’ll use EBITDA margin and Return on Investment (ROI) as measures of profitability and return. Vonage Holdings Corp. (VG) has an EBITDA margin of 7.02%, compared to an EBITDA margin of 32.6% for Level 3 Communications, Inc. (LVLT). This suggests that LVLT underlying business is more profitable. VG’s ROI is 5.70% while LVLT has a ROI of 5.70%. The interpretation is that VG’s business generates a higher return on investment than LVLT’s.
The value of a stock is simply the present value of its future free cash flows. VG’s free cash flow (“FCF”) per share for the trailing twelve months was +0.04. Comparatively, LVLT’s free cash flow per share was +0.64. On a percent-of-sales basis, VG’s free cash flow was 0% while LVLT converted 2.84% of its revenues into cash flow. This means that, for a given level of sales, LVLT is able to generate more free cash flow for investors.
Liquidity and Financial Risk
Analysts look at liquidity and leverage ratios to assess how easily a company can cover its liabilities. VG has a current ratio of 0.60 compared to 1.80 for LVLT. This means that LVLT can more easily cover its most immediate liabilities over the next twelve months. VG’s debt-to-equity ratio is 0.21 versus a D/E of 0.96 for LVLT. LVLT is therefore the more solvent of the two companies, and has lower financial risk.
VG trades at a forward P/E of 29.24, a P/B of 3.74, and a P/S of 1.81, compared to a forward P/E of 29.55, a P/B of 1.68, and a P/S of 2.33 for LVLT. Given that earnings are what matter most to investors, analysts tend to place a greater weight on the P/E.
Analyst Price Targets and Opinions
A cheap stock is not necessarily a value stock. Most of the time, a stock is cheap for good reason. A stock only has value if the current price is substantially below the price at which it should trade in the future. VG is currently priced at a -15.32% to its one-year price target of $9.53. Comparatively, LVLT is -14.65% relative to its price target of $61.45. This suggests that VG is the better investment over the next year.
The average investment recommendation on a scale of 1 to 5 (1 being a strong buy, 3 a hold, and 5 a sell) is 1.60 for VG and 2.90 for LVLT, which implies that analysts are more bullish on the outlook for LVLT.
Risk and Volatility
Analyst use beta to measure a stock’s volatility relative to the overall market. Stocks with a beta above 1 tend to have bigger swings in price than the market as a whole, the opposite being the case for stocks with a beta below 1. VG has a beta of -0.08 and LVLT’s beta is 1.23. VG’s shares are therefore the less volatile of the two stocks.
Insider Activity and Investor Sentiment
Analysts often look at short interest, or the percentage of a company’s float currently being shorted by investors, to aid in their outlook for a particular stock. VG has a short ratio of 3.83 compared to a short interest of 2.54 for LVLT. This implies that the market is currently less bearish on the outlook for LVLT.
Vonage Holdings Corp. (NYSE:VG) beats Level 3 Communications, Inc. (NYSE:LVLT) on a total of 8 of the 14 factors compared between the two stocks. VG is growing fastly, generates a higher return on investment and has lower financial risk. In terms of valuation, VG is the cheaper of the two stocks on an earnings and sales basis, VG is more undervalued relative to its price target.Finally, DLTR has better sentiment signals based on short interest.