Telephone and Data Systems trades at $38.90 and has moved in lockstep with the market. Its shares have returned 7.3% over the last six months while the S&P 500 has gained 8.6%.

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Why Do We Think Telephone and Data Systems Will Underperform?

We're cautious about Telephone and Data Systems. Here are three reasons we avoid TDS and a stock we'd rather own.

1. Revenue Spiraling Downwards

Examining a company’s long-term performance can provide clues about its quality. Any business can experience short-term success, but top-performing ones enjoy sustained growth for years. Telephone and Data Systems struggled to consistently generate demand over the last five years as its sales dropped at a 1.5% annual rate. This wasn’t a great result and signals it’s a low quality business.

2. EPS Trending Down

We track the long-term change in earnings per share (EPS) because it highlights whether a company’s growth is profitable.

Sadly for Telephone and Data Systems, its EPS declined by 21.9% 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. High Debt Levels Increase Risk

Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.

Telephone and Data Systems’s $4.22 billion of debt exceeds the $540 million of cash on its balance sheet. Furthermore, its 20× net-debt-to-EBITDA ratio (based on its EBITDA of $182 million over the last 12 months) shows the company is overleveraged.

At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Telephone and Data Systems could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.

We hope Telephone and Data Systems can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.

Final Judgment

We cheer for all companies making their customers lives easier, but in the case of Telephone and Data Systems, we’ll be cheering from the sidelines. That said, the stock currently trades at 3.8× forward EV-to-EBITDA (or $38.90 per share). This valuation tells us it’s a bit of a market darling with a lot of good news priced in - we think other companies feature superior fundamentals at the moment. We’d suggest looking at an all-weather company that owns household favorite Taco Bell.

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