Lumen has been on fire lately. In the past six months alone, the company’s stock price has rocketed 133%, reaching $7.15 per share. This was partly thanks to its solid quarterly results, and the run-up might have investors contemplating their next move.
Is there a buying opportunity in Lumen, or does it present a risk to your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free for active Edge members.
Why Do We Think Lumen Will Underperform?
We’re glad investors have benefited from the price increase, but we're cautious about Lumen. Here are three reasons we avoid LUMN and a stock we'd rather own.
1. Revenue Spiraling Downwards
A company’s long-term sales performance is one signal of its overall quality. Even a bad business can shine for one or two quarters, but a top-tier one grows for years. Lumen struggled to consistently generate demand over the last five years as its sales dropped at a 9.5% annual rate. This was below our standards and signals it’s a low quality business.
2. EPS Trending Down
Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.
Sadly for Lumen, its EPS declined by 16.4% annually over the last five years, more than its revenue. This tells us the company struggled because its fixed cost base made it difficult to adjust to shrinking demand.
3. Free Cash Flow Margin Dropping
If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.
As you can see below, Lumen’s margin dropped by 9.2 percentage points over the last five years. It may have ticked higher more recently, but shareholders are likely hoping for its margin to at least revert to its historical level. If the longer-term trend returns, it could signal increasing investment needs and capital intensity. Lumen’s free cash flow margin for the trailing 12 months was 9.1%.
Final Judgment
We cheer for all companies making their customers lives easier, but in the case of Lumen, we’ll be cheering from the sidelines. Following the recent rally, the stock trades at 2.2× forward EV-to-EBITDA (or $7.15 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are better investments elsewhere. Let us point you toward one of our all-time favorite software stocks.
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