July 15, 2012 in Business

Motley Fool: Telefonica’s potential may be worth taking a risk

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Associated Press photo

Martha Stewart unveils a line of home office products with Staples officials in February in New York. Martha Stewart Living’s stock has lost money for investers on a consistent basis, but new partnerships offer hope.
(Full-size photo)

Europe has been an economic battlefield for quite a while now, with Spain recently near the epicenter. Investors are shying away from Spanish telecom giant Telefonica (NYSE: TEF), fearing a European slowdown that could hurt its future earnings. That might be shortsighted, though.

Investors have painted Telefonica with the same brush that they’ve used for most other telecom stocks in Europe, avoiding the stocks as dividends look to fall and economists begin to project a long potential European recession.

But what those investors ignore is the fact that Telefonica has more exposure to Latin America than to Spain. Although not quite half of its sales come from Latin America, its operations there are more profitable, and thus it generates more than 60 percent of the company’s operating income.

Of course, Latin America has had its own troubles. But with Brazil hosting the World Cup in 2014 and the Olympics in 2016, it will likely want to bulk up its telecom system to put on a good face for visitors. And although Telefonica faces plenty of competition, the market is large enough to give everyone a chance to profit.

Telefonica recently yielded more than 10 percent, but expects to cut its dividend in 2012 and 2013. It may be a high-risk, high-potential- reward way to bet on Europe turning out better than many fear.

Ask the Fool

Q: How can a company’s earnings per share rise when its earnings don’t grow? – S.S., Portland, Maine

A: It happens when the share count shrinks. Imagine that Bright Idea Light Bulbs (ticker: UREKA) has 10 million shares outstanding and earns $50 million in a quarter. Its earnings per share (EPS) is $5. If it buys back a million shares and then earns $50 million again in the next quarter, its EPS has suddenly risen to $5.56 (50 million divided by 9 million equals 5.56).

Share buybacks can be good, making remaining shares worth more – as long as they don’t happen when the stock price is overvalued.

My dumbest investment

My dumbest investment was in Martha Stewart Living Omnimedia. I like Martha Stewart, have the highest admiration for her business abilities and still enjoy her shows. However, I bought the stock for emotional reasons and only recently sold it, losing money. – M.C.H., Mount Pleasant, Mich.

The Fool responds: Your experience reminds us all that it’s important to separate what we might feel about a stock from what our rational brains think about it. It’s not enough for a company to have a product you love. Lots of people have to love it, and the company needs to be making money, enjoying competitive advantages and growing. Its stock also needs to be undervalued, so that it’s more likely to rise than fall.

Martha Stewart Living’s stock has lost money for investors, on average, over the past decade. Its current detractors point to several years of losses and shrinking revenue. Bulls are hopeful about partnerships with JC Penney and Home Depot and possible revenue from the company’s presence on Pinterest.com, among other things. The company may perform well from this point on, but it’s risky.

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