Should You Buy the Highest-Yielding Stock in the S&P 500?

I know it's tempting... But sometimes, as an income investor, when you see a stock yielding 10%, 11% or even more -- it pays to hold off on pulling the trigger with that buy order.

The good news is that sometimes all it takes is a little homework, including an understanding of the risk involved and a proper expectation of performance. If it still looks appealing, then by all means, make the purchase.

I recently ran into this situation when asked about a former holding in my High-Yield Investing newsletter.

It's understandable. In fact, I imagine this stock has shown up in a lot of investors' screens for high-yielders or losing stocks that might now be bargains. So I thought it would be worthwhile to tell you about the stock and why it might be worth considering for your portfolio.

The stock is Frontier Communications (Nasdaq: FTR), a rural telecom that has about 15,400 employees and provides telephone, broadband, satellite TV and wireless Internet services to households and businesses in small to mid-sized markets in 27 states.

As readers of my High-Yield Investing newsletter know, I removed Frontier from my portfolio about five months ago. At that time, it was trading above $4.50 a share. Since then, the shares have lost about 20% and the quarterly dividend has been cut nearly in half, to $0.10 per share from $0.188. Still, the shares offer a tempting 10%-plus yield at this dividend rate.

So is Frontier a steal at today's price?

The shares fell steadily throughout May and in Early June, declining 10% in May alone. But the shares have recently started to gain traction -- the stock is up close to 16% in less than 2 weeks.

We've yet to see if this is just a short term change in the stock's momentum, or a reversal of the company's fortune.

Meanwhile, insiders have been buying. In the past couple weeks alone, executives and board members scooped up about 40,300 shares at average prices of $3.28 to $3.34 a piece.

The company is profitable. First-quarter earnings totaled $26.8 million, or $0.03 per share. Free cash flow of $253 million amply covered the first-quarter dividend by 2.5 times.

Moreover, the shares are trading well below their book value of $4.39 per share. (Simply put, book value is what you would get after all debts are paid, if the company were to liquidate.)

Let me warn you though, that's not to say all is well with this telecom. Revenues are declining as the loss of landline customers is not being offset by growth in broadband Internet and TV.

Management also has an atrocious dividend record. The dividend was cut twice in the last two years, and the latest cut came less than a year after management assured shareholders there was enough free cash flow to maintain the dividend at the then-current rate.

So Frontier is not for the faint-hearted...

If you're willing to speculate on a higher-yield play that could be oversold and undervalued at today's price, Frontier may be worth considering. But if you're looking for a reliable dividend grower with steady cash flow, you should probably look elsewhere.

Good Investing!

Carla Pasternak's Dividend Opportunities

Disclosure: Neither Carla Pasternak nor StreetAuthority own shares of the securities mentioned in this article. In accordance with company policies, StreetAuthority always provides readers with at least 48 hours advance notice before buying or selling any securities in any "real money" model portfolio. Members of our staff are restricted from buying or selling any securities for two weeks after being featured in our advisories or on our website, as monitored by our compliance officer.