What Are the Best Metrics to Evaluate a Telecommunications Company?

To effectively evaluate a telecommunications company, it's important to look at metrics that specifically affect the telecommunications sector. Evaluating any stock requires specific knowledge about the company's sector and industry, as well as knowledge of the particular forces that impact companies in the same category. For example, factors that affect profits in a shipping company are much different than those affecting a bank's bottom line.

Fortunately for investors, telecommunication companies report various performance metrics that are specific to their industry. In this article, we'll list a few key fundamental metrics common to most companies that investors should be aware of when evaluating a company for potential investment. Next, we'll review those metrics unique to the telecommunications industry that give investors insight into a company's financial health.

Fundamental Analysis

An investor who uses fundamental analysis to evaluate a company strives to come up with a fair market value or price for where they think a stock should be trading. They will look at quantitative metrics—usually gleaned from a company's quarterly and annual financial statements—to determine the company's intrinsic value.

When analyzing a company's financial statements, investors will review a variety of metrics, including assets, liabilities, stockholders' equity, debt, and free cash flow. When taken alone, any one of these fundamental indicators will generally not be enough to confirm a company's viability as a potential investment. However, when combined, these metrics can paint a clear picture to an investor of a company's financial well-being and potential for profitability.

In the telecommunications sector, three additional metrics stand out that can help investors in their evaluation process: average revenue per user (ARPU), churn rate, and subscriber growth.

Average Revenue Per User (ARPU)

This average revenue per user (ARPU) is calculated by dividing the total revenue for a period by the average number of users. This is an important metric in the telecommunications industry as it illustrates the company's operational performance. The ability to maximize profits and minimize costs associated with servicing each end user is key to these companies.

Because telecommunications companies are service providers instead of manufacturers of a product, investors want to measure marginal profit and cost on a unit level, revealing how well the company utilizes its resources. The higher the average revenue, the better. Generally, telecommunications companies that offer bundling services enjoy a higher ARPU.

Churn Rate

The churn rate is a metric that measures the number of subscribers who leave and is often reported quarterly or annually. Internet providers, cable and satellite TV providers, and telephone service providers (both landline and wireless service) track their churn rate, which is usually reported as a percentage. For example, if two out of every 20 subscribers of a wireless phone service cancel their subscriptions in a year, the company would report an annual churn rate of 10%.

Obviously, a low churn rate is ideal. Companies that experience a high churn rate are under more pressure to generate revenue from other areas or gain new clients.

Subscriber Growth

A telecommunications company's future revenue growth has much to do with its ability to grow its customer base and add new subscribers. Subscriber growth is, therefore, an extremely important metric. A steady subscriber growth rate indicates a competitive telecommunications company that is keeping up with technology trends, thereby keeping customers happy and attracting new customers. When reporting subscriber growth, telecommunications companies will often report what is called "net additions" and will break down this category by product line.

The Bottom Line

While individual stocks in the telecom sector can be volatile and exhibit price fluctuations, the sector as a whole has exhibited long-term stability and growth. Both consumers and businesses have become increasingly dependent on the telecoms to provide a wide array of voice, video, text, and data services. This trend doesn't seem to be on the verge of slowing down and innovative telecoms should continue to be profitable. While some investors prefer to review company metrics and select individual stocks for their portfolio, an alternative is to invest in a top telecommunications exchange-traded fund (ETF) for broader exposure to the sector.