One of the most important skills a value investor can have is being able to tell the difference between a value stock and a value trap.
Take AT&T (T 1.88%), for example. The telecom giant has long been popular for its high dividend yield, but its stock performance has been consistently underwhelming. Check out the chart below.
While AT&T's dividend has saved it from negative returns over the last decade, it trails the S&P 500 index significantly as well as its rivals Verizon and T-Mobile.
Going into 2023, some investors seem to see value in AT&T stock after it has fallen sharply in 2022. It now pays a dividend yield of 6.1%, and the stock looks cheap at a price-to-earnings ratio of 7. Despite those numbers, investors are best off avoiding AT&T stock in 2023. Here's why.
1. AT&T's growth remains sluggish
AT&T's revenue growth has been slow for years, and the company even lost its title as the No. 2 wireless carrier, falling behind T-Mobile in 2020.
In its most recent quarter, revenue adjusted for the recent sale of its U.S. video business increased 3.1% to $29.1 billion. That may sound decent for a mature industry like telecom, but it actually trails the inflation rate. AT&T raised prices on some of its plans and has been aggressive with promotions in order to grow its user base, but the company also trimmed its free cash flow guidance for the year. With a recession expected in 2023, customers could be more sensitive to paying up for additional services, making it harder to grow revenue.
The analyst consensus currently calls for revenue to fall 4% in 2023, and the combination of intense competition for customers and rising costs seems likely to put added pressure on AT&T in 2023.
2. The stock isn't as cheap as it looks
According to its P/E ratio, AT&T stock may look cheap, but the earnings multiple doesn't take into account the massive debt burden on its balance sheet. Thanks to a pair of misguided acquisitions, the company has $133 billion in debt on its balance sheet, and while most of that debt is at a fixed interest rate, higher interest rates will make it more expensive for the company to roll over that debt when it matures. Currently, AT&T is paying about $6 billion in annual interest expense, and if interest rates remain high over the coming years, investors should expect those payments to increase.
Additionally, AT&T's debt burden needs to be factored into its valuation as it's even higher than its market cap of $129 billion.
In other words, AT&T's enterprise value, or what a prospective buyer would actually owe, is twice as much as its market cap, meaning its P/E ratio, including its debt, is more like 15.
AT&T is focused on paying down that debt, but those obligations will also suck away resources that could be used to invest in the business or return capital to shareholders.
Additionally, the company also has $93 billion in goodwill on its balance sheet, making it vulnerable to a future impairment charge.
3. Management has made questionable moves
AT&T has arguably executed two of the worst acquisitions of the last decade. In 2015, the telecom paid $67 billion -- including debt -- for DirecTV, the satellite TV service, even as Pay TV was in evident decline. AT&T spun off DirecTV and its other video assets last year at a greatly diminished value.
Similarly, the telecom acquired Time Warner in 2018 for $85.4 billion, giving it control of another suite of television networks including HBO, TNT, TBS, CNN, and the Warner Bros. movie studio. Just three years later, AT&T had spun out Time Warner's primary assets in a merger with Discovery, forming Warner Bros. Discovery, which now has a market cap of just $21.5 billion, a remarkable destruction of value for the second time in a few years.
Like the DirecTV deal, AT&T's timing was once again disastrous as it paid a premium for cable assets on the eve of an explosion in streaming content, accelerating the shift from linear TV to streaming.
AT&T is currently led by John Stankey, who was not CEO during either of those deals, but was in charge of WarnerMedia, the renamed Time Warner division following the deal, and presided over a clash between AT&T management and Time Warner's Hollywood talent.
AT&T has shed its media assets and is solely focused on telecom, but it still has the bloated debt burden left over from the two failed acquisitions. Given management's track record, especially Stankey's failure with Time Warner, investors can likely find better places to put their money.
After years of challenges, 2023 is unlikely to be any different for the telecom stock.
