Investors, It's Time to Switch Wireless Carriers

Adam Fischbaum's picture

Thursday, April 6, 2017 - 11:30am

by Adam Fischbaum

As the U.S. wireless telecom backbone has evolved since its infancy of the late 1990s, the game, save for a few minor players, has been dominated by two companies: AT&T (NYSE: T) and Verizon (NYSE: VZ). Combined, the two own about 65% of the U.S. market. With 142.7 million subscribers, Verizon holds the top spot over AT&T's 131.8 million customers.

It's also common knowledge that the stocks of both companies are perennial favorites among dividend investors. Many hold both in their portfolios. After all, it makes sense to own both number one and two. But does it make more sense to hold just one of them?

At first glance, the two stocks look almost identical. As of this writing, T shares trade around $41.50 with a 4.7% dividend yield, while VZ shares seem a little pricier at about $49.20 per share with a 4.7% yield.
But a look underneath the hood on both stocks tells a much different story. Here's what I found.

Stronger Signal?
  AT&T Verizon
Two-Year ROE 11.66% 95.90%
Two-Year Div. Payout Ratio 97.13% 47.70%
Two-Year EPS Growth 43.50% 27.02%
Two-Year Avg. Total Return 18.60% 12.00%
 

While AT&T's earnings per share (EPS) growth blew past Verizon's, driving the total return numbers up with it, the real question is what will growth look like going forward and how sustainable is it? Based on Verizon's return on equity (ROE) and dividend payout ratio, I'm going with Verizon.

ROE is the amount of net income returned as a percentage of shareholder equity. The metric seeks to measure a company's profitability by showing the amount of profit that business has generated with the money shareholders have invested. Comparing the two-year average annual ROE of both T and VZ, VZ was 722% more profitable than T.

Another "tell," as they say in poker, is the dividend payout ratio. A company's dividend payout ratio is the percentage of retained earnings paid out to common shareholders in the form of dividends. While a good measure of how shareholder-friendly a company may be, this ratio is also an indication of how well the company handles its cash.

Currently, AT&T is paying out nearly all its retained earnings to support its attractive 4.7% dividend. Historically, my rule of thumb for an acceptable payout ratio has been 60% or lower. Now keep in mind, AT&T acquired satellite television provider DIRECTV in 2015 for $67.5 billion. A merger of that size can jumble up the numbers for the near term due to merger related costs and other items. That could be one explanation of T's 97%-plus payout ratio.

However, AT&T isn't just satisfied with owning a media distribution network via big and small screens. It wants to own the content as well. Late last year, the company announced plans to acquire media icon Time Warner (NYSE: TWX) for $85 billion. Although the addition of a top shelf content portfolio will eventually contribute to AT&T's cash flow immensely, I don't see another large acquisition bringing that payout ratio down in the near term.

While the regulators are still deliberating the proposed marriage (the odds for approval are favorable under the new Trump administration), Verizon has been transforming itself into a multi-media entity as well, purchasing web portal AOL for $4.4 billion, and is nearing the close of its purchase of Yahoo's (Nasdaq: YHOO) web search and content business for $4.8 billion.

I see these as necessary steps Verizon must take to remain competitive in the rapidly evolving media space. However, Verizon is doing so at a fraction of the cost when compared to rival AT&T. The net result will be unimpeded cash flow that should drive earnings organically, allowing continued investment while protecting the dividend.

I'm not implying that AT&T's dividend is in danger. As a media behemoth, T will be able to pay shareholders in the fashion they've become accustomed to. But its operational and acquisition needs will have to be funded with debt. The company should be able to manage this, but I'm afraid in the near to medium term any significant earnings growth will suffer. Not so for Verizon.

Risks To Consider: While VZ holds the number one spot in the U.S. wireless telecom space, T's large yet bold move to become a true multi-media network, a 'la Comcast's (Nasdaq: CMCSA) purchase of NBC Universal from General Electric (NYSE: GE), could change that thanks to T's bundled strategy capturing the consumers' wallet and eyeballs on all screens. VZ has caught criticism for chasing after the same goal but purchasing "has been" properties.

Action To Take: Current holders of T shares should consider taking profits or at least partial profits on their current positions and switching into VZ. Investors looking to add new money should choose VZ over T.

T shares currently trade at a 5% discount to their 52-week high with a forward P/E of about 14.2 and a 4.7% dividend yield. VZ shares trade at a much more attractive 13.3% discount to their 52-week high with a more value oriented forward P/E of 12.8. The dividend yield is similar at 4.68% thus keeping investor income at a consistent level.

The bottom line is upside. AT&T looks tired. Based on the numbers, VZ offers 12- to 18-month total upside of 22% when factoring in the dividend.

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Adam Fischbaum owns shares of VZ.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.