Don't Buy Verizon Without Looking at These Stocks First

Verizon Communications (NYSE: VZ  ) shares are down more than 6% in 2010 while the Dow Jones industrial average is slightly positive. For investors who are attracted to its 6.4% dividend yield, Verizon may look like a pretty good buying opportunity. On the positive side, its forward price-to-earnings ratio looks relatively cheap at 12.8 and is trading near its 52-week low. Verizon's wireless business is generating a whopping $12 billion in free cash flow. Plus, rumors persist that the iPhone will finally come to Verizon in November or January. So Verizon's forward-looking valuation combined with the potential iPhone catalyst might argue that Verizon is a lock to outperform the Dow moving forward -- providing investors with both an attractive dividend and capital appreciation opportunity.

But hold on just a minute. On the negative side, Verizon's trailing price-to-earnings ratio looks positively expensive at 113, light years higher than the industry average of 18.2. And Verizon's payout ratio (the percentage of a company's net income that is used to pay its dividend) is listed at a whopping 728%.  This suggests that Verizon will need to free up cash from its wireless business unit to maintain such an attractive dividend. But Verizon won't be able to grab all of the $12 billion because Vodafone (Nasdaq: VOD  ) owns 45% of Verizon's wireless unit.

So color the situation for Verizon a bit murky. Will the positives lift Verizon's share price, or will the negatives create a drag on share prices and even put its healthy dividend at risk?

We asked our Motley Fool CAPS community to nominate two Telecommunication Services peers that are likely to outperform Verizon.

And the nominees are
Our 165,000-plus-member CAPS community views America Movil (Nasdaq: AMX  ) , Latin America's largest mobile carrier, as a better opportunity among similarly sized companies in telecommunications. America Movil is a five-star stock (the highest rating given by our CAPS community), and Verizon currently stands as a four-star stock.  CAPS member judged333 succinctly summarizes the general CAPS community sentiment in a February comment: "I'll tolerate the volatility for the potential growth this offers in an emerging market."

America Movil's forward P/E is 12.1 and trailing P/E is 14.3 (both better than Verizon), but provides a paltry 0.5% dividend yield. So, America Movil won't be attractive to the dividend investor, but it could be a better opportunity for capital appreciation. America Movil's free cash flow margin (defined as FCF / trailing-12-month revenue), is among the highest of its peer group, with 23% of its revenue turning into free cash flow (vs. 14% for Verizon). With plenty of growth potential in the emerging Latin American market, America Movil could have lots of upside. The company has been aggressively positioning itself to dominate the future 4G wireless network market in Mexico. And earlier this year, America Movil announced plans to acquire landline and broadband companies Telefonos de Mexico (NYSE: TMX  ) and Telmex Internacional (NYSE: TII  ) to offer bundled wireless, fixed-line, Internet, and TV. In June, America Movil assumed primary ownership of both companies. Whether America Movil delivers for shareholders probably depends on how successfully it integrates these two companies and whether the future 4G and wireless data are a catalyst for the next phase of growth in the business.

Another alternative for Verizon investors is Vodafone. As mentioned above, Vodafone owns 45% of Verizon's wireless business and stands to benefit handsomely when Verizon's wireless unit starts to put all that free cash flow back into the business. The stock offers a 5.6% dividend yield with a payout ratio of 48%. And Vodafone's current and forward P/E is about 9. Given that its valuation looks a bit more attractive than either Verizon or America Movil, Vodafone might provide the best combination of attractive dividend and attractive capital appreciation opportunity.

Make your vote count!
Do you agree that America Movil and Vodafone may be better buys than Verizon? Click over to CAPS and let the rest of the community know what you think.

John Keeling doesn't own shares of any company mentioned. America Movil is a Motley Fool Global Gains selection. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 04, 2010, at 7:49 PM, bcfran wrote:

    "So color the situation for Verizon a bit murky. Will the positives lift Verizon's share price, or will the negatives create a drag on share prices and even put its healthy dividend at risk?"

    You can not be serious? I would say irresponsible at best... to suggest that Verizon's dividend is at risk in any way in the short term is ludicrous. To measure VZ's valuation as a multiple of net income shows you have a dubious agenda or are ignorant about the company and should not be writing articles on it.

    Come on. You know better. Shame on Morley Fool for allowing propaganda like this to be disseminated.

  • Report this Comment On August 04, 2010, at 11:13 PM, TMFJake wrote:

    @bcfran: I am serious that Verizon will need the cash flow from its wireless business unit to continue to pay such high dividend. My comments about VZ's net income were solely related to the dividend issue, and is meant to reinforce the likelihood that wireless fcf will be tapped to maintain the current dividend yield--whereas currently Verizon is using the cash from the wireless unit to pay down debt.

    I have no agenda, but I think someone evaluating Verizon should think through Vodafone's stake in Verizon wireless, and what it means when Vodafone starts to receive some of the cash generated from the wireless unit. And, per the CAPS community recommendation, I do think America Movil is an interesting, albeit risky, alternative for investors primarily focused on capital appreciation.

    I'm not saying Verizon isn't a worthy investment, but I am saying it would be irresponsible not to look at these alternatives.

  • Report this Comment On August 05, 2010, at 1:36 AM, Puckplayr4 wrote:

    Ahhh...I feel so smart! I actually just started picking up Vodafone last month for pretty much all the reasons above. I like verizon, and knowing Vodafone owns a big chunk of it made it a lot more attractive...and the dividend, and the international presence and growth opp. Great article.

  • Report this Comment On August 05, 2010, at 11:09 AM, energysystems wrote:

    I'm long VOD, it has a great position in the American cell market with it's 45% stake in VW, and is one of the largest international cell companies with no land line legacy issues. It's is aggressively going after emerging markets and is making deals around the globe to increase market share. Solid dividend is a big plus, along with organic growth.

  • Report this Comment On August 06, 2010, at 10:34 AM, bunngolf wrote:

    Have your cake and eat it too. I own both VOD and VZ. Good growth potential for both. VZ has been shedding their shrinking rural hard line exposure to concentrate more on larger metro area FIOS bundling and, of course, expanding wireless. VOD is a great play on developed wireless markets as well as emerging and frontier markets.

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