Frontier Communications Corporation's Best Move in 2016 So Far

By Markets

Image source: Frontier Communications.

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High-yielding dividend stocks draw a lot of attention, and many investors therefore know Frontier Communications (NASDAQ: FTR) well. The telecom company ranks near the top of the stock market with its dividend yield of nearly 10%, and those who rely on the income that Frontier shares provide have appreciated its ability to keep paying that dividend over the past four years. Indeed, one of the best moves that Frontier has made not only this year but over the long run is to sustain its dividend rather than use other methods of returning capital to shareholders. By emphasizing dividends, Frontier has given its shareholders the choice of whether to stick with the telecom company or seek out greater diversification by investing in other stocks. Let's take a closer look at the decisions that Frontier has made to support its dividend as the highest priority element of its capital management.

Dividends vs. buybacks

Companies that have free cash flow that they don't want to reinvest into their businesses always have to decide the best way to use their spare cash. Dividends are one primary way that companies return capital to shareholders, but the other is to repurchase shares of stock.

Many companies in the broader stock market use a combination of these strategies in order to demonstrate their shareholder-friendly ways. For instance, tech giant Microsoft has paid total dividends to shareholders amounting to $11 billion over the past 12 months. However, it has also bought back nearly $16 billion in stock, helping both to reduce the dilutive effect of option-based compensation and to reduce the number of shares outstanding, thereby amplifying earnings-per-share metrics.

Some telecom companies have made occasional forays into major buybacks. Industry giant Verizon (NYSE: VZ) did an accelerated $5 billion stock buyback program last year, but that was the first significant buyback of any size for Verizon since 2008. Similarly, AT&T (NYSE: T) did large buybacks in 2012 and 2013, totaling almost $26 billion. Yet in the three years before that, AT&T didn't repurchase any shares, and since then, its buybacks have been much smaller, amounting to just a fraction of what it pays out to investors in dividends.

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Resisting the urge to spend on stock

Frontier's low share price has led some to consider whether stock repurchases might be a better use of capital than dividends. Yet Frontier hasn't done a stock buyback since 2008, and it has shown little inclination to consider repurchases as a supplement to or a replacement for dividends.

Indeed, Frontier has actually gone the other way on occasion, issuing new shares as part of its acquisition efforts. For instance, last year, Frontier issued about $800 million in common stock and roughly $1.9 billion in preferred stock to help finance the Verizon deal. By doing so, the telecom avoided having to raise even more debt. Moreover, the preferred stock is required to convert into common shares in the future, which will effectively lock in equity financing that will keep Frontier's balance sheet healthier.

If Frontier had bought back stock in the past, it only would have found itself in the uncomfortable situation of having to reverse course in funding acquisitions. All too often, companies make bad decisions with buybacks, repurchasing shares when prices are high and then having to issue stock during tougher times when share prices are low. Looking at Frontier's share-price behavior in recent years, investors who took their dividend income and reinvested it elsewhere have been able to capitalize on better performance from the stock market overall.

Perhaps most importantly, the way that Frontier sets up its capital return policy gives investors the choice of what to do. If they want to reinvest in Frontier shares, they can do so. If they prefer to diversify elsewhere, they have that option as well. With buybacks, a company essentially forces its existing investors to buy in, with the only alternative being to sell their shares.

Frontier has gone through major challenges, but the choice it made to keep paying dividends rather than using share buybacks has worked out well for investors. By putting shareholders in control, Frontier lets all of its investors do what they think will be most profitable for their portfolios in the long run.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Verizon Communications. 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.