Written by Robert Kovacs
The debate will surely never end. Should dividend investors should favor AT&T (T) or Verizon (VZ) or both? One side claims that AT&T’s superior dividend yield gives it an edge, while the other side touts VZ’s history of capital gains as proof of the stock’s superiority.
I have a clear favorite for the type of dividend strategy I run.
This article will compare AT&T and Verizon using the typical framework we use for analyzing stocks.
I will first analyze the stocks’ dividend profiles, before considering their potential for stock market-beating performance in upcoming quarters.
Just looking at our MAD Scores would leave you confused as to which stock is the better pick, as there aren’t too many apparent differences between both.
Dividend Strength Score
Stock Strength Score
Let’s get started analyzing T and VZ’s dividend profiles.
Both Verizon and AT&T have been paying growing dividends for a long time, and their dividend profiles look very much alike if it wasn’t for one detail: dividend yield.
Dividend growth 1 year
Dividend CAGR 5 years
Dividend CAGR 10 years
Earnings payout ratio
Cash from operations payout ratio
Free cash flow payout ratio
As you can see, not only dividend growth for both telecom stocks has been very similar, a consistent 2% per annum (give or take) for the past decade. While AT&T’s earnings don’t cover the dividend, earnings payout has always been an inferior metric, as dividends are paid from cash flow not from earnings. In that respect, AT&T and Verizon are very similar, generating massive amounts of cash, plenty enough to pay the dividend with a good margin of error.
Both companies are extremely dedicated to their dividends. In my mind, this comes without a doubt.
In the latest earnings call, AT&T management stated that:
Through it all, we expect to come through this healthy and expect that our cash flow will allow us to continue to invest in growth areas, to provide ample dividend coverage, and allow us to retire debt.
While Verizon’s management stated that:
Number one is the business. Number two is the shareholders. Three is the debt reduction and number four is the buyback. And we feel that we’re in a really good situation to continue to put our Board in the right position to serve our shareholders with dividend.
Both businesses have similar priorities and ability to pay the dividend. Both dividends are safe, there is no real debate here I believe.
I believe AT&T will continue increasing its quarterly dividend at the current rate of $0.01 per year, while VZ will increase at $0.0125 as it has been doing.
Over the next 10 years that would equate to 1.77% CAGR for AT&T and a 1.85% CAGR for Verizon.
So for investors analyzing the dividend profile, the real difference comes down to the dividend yield.
Verizon yields 4.38%.
This yield isn’t that high compared to Verizon’s history. During the past decade, the stock has traded at a median yield of 4.5%, and in 70% of the trading days, it closed with a dividend yield higher than the current yield.
That doesn’t exactly scream bargain.
AT&T yields 6.86%.
During the past decade, AT&T has yielded a median 5.48%. In fact, in only 2.5% of trading days has AT&T’s dividend yield been higher than it currently is.
Source: data from mad-dividends.com
The chart above shows the difference in percentage points between T’s yield and VZ’s yield. The yield gap has nearly never been this wide.
This has happened as AT&T’s yield has shot up to unusually high levels, while VZ’s yield is actually low relative to its own history.
But does the difference in yield really matter? Simply put, yes, it does.
Let’s run a little simulation to prove this. We’ll suggest that we invest $10,000 in VZ at current prices. We’ll project over 10 years. We’ll assume that VZ’s dividend grows at a 1.85% CAGR. We’ll assume that we reinvest dividends at the end of each year at the same 4.38% yield.
These parameters are shown in the simulation below.
By year 2030, an investment of $10,000 in Verizon would bring in $771 in annual dividends, of which $246 would be generated from having reinvested the dividends throughout the decade.
Now let’s run the exact same simulation but for AT&T. We’ll assume that the dividend grows at a 1.77% CAGR, and that dividends are reinvested at the current 6.86% yield.
In 10 years, a $10,000 investment in AT&T would be expected to generate $1,479 in annual dividends, of which $664 would come from having reinvested the dividends throughout the year.
But what if T returns to its median yield? Even if all subsequent reinvestments of the dividend were done at T’s median yield of 5.48%, you’d still be able to expect $1,314 in annual dividends 10 years down the line.
And if you’re wondering, the gap would never close.
If you’re investing for dividend income in retirement, there is no doubt that at current prices, AT&T is the better pick.
But what about capital gains you might ask?
It is true, during the last 10 years, Verizon’s stock price has increased 100%, while AT&T is up only 20%.
But ask yourselves, do you believe this is going to happen again? If Verizon’s dividend increases by an average 1.85% per year for 10 years, yet the stock price doubles, the yield would be down to only 2.6%.
Now I’m not discarding this as impossible, but let me say that it is highly unlikely that investors would value VZ in such a way that its yield comes that low. Of course it is extremely hard to see 10 years out in the future, and who knows what will happen?
But as far as making a statement goes, I’ll go on record saying there is no chance in hell that VZ’s yield will go down to 2.6% within the next decade. I also don’t believe the dividend will go up by much more than the amount I stated above.
If your goal is to generate dividend income for retirement, then a 2.48% spread in dividend yield with otherwise similar dividend profiles is huge, and AT&T wins.
Stock Strength Profile
But what of potential for capital appreciation relative to the market. Here we look at both stocks’ fundamental scores, which include our value, momentum and quality metrics before drawing conclusions.
Across all metrics, Verizon only has an edge relative to earnings. Verizon is trading at a historically low multiple of earnings as the chart below shows, it is trading pretty much at its 10-year 1st quartile multiple.
But AT&T is trading at a very similar multiple relative to its own history.
Historically, AT&T has traded at a 3-4x premium to Verizon. Yet relative to sales, the dividend and the operating cash flow, AT&T trades at lower multiples.
While both have extremely attractive value scores, AT&T edges slightly above.
3-month price change
6-month price change
12-month price change
Verizon has come out on top for momentum but not sufficiently to make a noticeable difference.
While AT&T has severely underperformed this year, tanking badly in March and only making a partial recovery, Verizon has taken less of a hit, and has better recovered, making it nearly flat year over year.
AT&T is dangerously close to our momentum level which would tell us to just not to buy because the market hates it. This doesn’t mean the market loves it, not by a close shot. Verizon has been behaving just slightly worse than the median US stock.
This has obviously contributed to the widening of the yield gap between both stocks. The market views Verizon as more stable, as many investors are fearful of the large amount of debt which AT&T has. But is that justified?
Change in Liabilities
CFO to Liabilities
Total Accruals to Assets
Depreciation to Capex
Return on Equity
Interest Coverage Ratio
So it is not as clear cut as that. Verizon has a slightly higher quality score, thanks to its superior asset turnover, return on equity, interest coverage ratio and cash liability coverage.
However, the differences aren’t sufficient to say that AT&T (which has lower gearing), is low quality. In fact, T’s coverage is totally acceptable for a telecom stock. Investors are scared of the size of T’s debt, but fail to see it in proportion to the amount of cash the company generates.
Both AT&T and Verizon are high-quality businesses, but once again Verizon comes out ahead.
Stock Strength Summary
The data above give AT&T a stock strength score of 87, and Verizon a stock strength score of 91. Both fantastic stock strength scores, which suggest that momentum relative to the market might be turning for both stocks. While VZ has slightly better quality, this is made up by AT&T’s slightly better value. Both stocks are nicely set up, because of their value and quality for the next 12 months.
When AT&T and Verizon are compared, I keep favoring AT&T because of its superior dividend yield, which does truly make a difference. You’d have a solid case to argue that I would have been better off in the past decade with VZ, but when I look at it again this time around, I believe T will come out on top and makes a better pick, especially with this unusually high dividend yield.
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Disclosure: I am/we are long T. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Originally published on Seeking Alpha