How Much Is AT&T Worth?

After enduring a wrenching stock market downturn, investors have once again started turning to the security and tangibility of dividends. Not surprisingly, that's meant a lot of attention for telecom providers since their stocks feature some of the market's fattest payouts. CenturyLink (NYSE: CTL  ) pays 6.6% while Verizon (NYSE: VZ  ) and AT&T (NYSE: T  ) both offer up 5.9%.

But while AT&T's dividend is juicier than a perfectly ripe Florida orange, is the stock worth buying? Let's take a closer look.

It's a beautiful day in the neighborhood
One way to get an idea of what a stock might be worth is to check out how similar companies are valued. So let's take a look at how AT&T stacks up.

Company

Total Enterprise Value / Trailing Revenue

Price / Forward Earnings

Total Enterprise Value / EBITDA

Price / Book Value

AT&T 1.9 11.9 5.5 1.5
CenturyLink 2.9 13.8 5.6 1.4
Leap Wireless (Nasdaq: LEAP  ) 1.3 NM 6.1 0.8
MetroPCS (NYSE: PCS  ) 1.8 14.4 6.5 1.8
Sprint Nextel (NYSE: S  ) 0.9 NM 5.9 0.8
Verizon 1.8 15 5.3 2.5
Windstream (Nasdaq: WIN  ) 3.8 16.9 7.8 NM
Average* 2.1 15 6.2 1.5

Source: Capital IQ (a Standard & Poor's company) and Yahoo! Finance.
*Average excludes AT&T.
NM = Not meaningful.

Using each of those averages to back into a stock price for AT&T, and then taking the average across those results, we can come up with an estimated price per share of roughly $32. This would suggest today's price just shy of $29 is somewhat undervalued.

A comparable company analysis like this can sometimes raise as many questions as it answers, though. For instance, is the entire group properly valued? A supposedly fairly valued -- or even overvalued -- stock among a bunch of other undervalued stocks may actually be an undervalued stock, and vice versa.

Also, while these businesses are comparable to AT&T, none is a perfect match. CenturyLink and Windstream both focus primarily on land-line communications. Leap and MetroPCS are both wireless carriers, but are much smaller up-and-coming players. Sprint Nextel has a pretty comparable business, but its struggles make it more of a turnaround story than a blue-chip performer. And while Verizon is a very similar business, the details still aren't quite the same, including (at least for now) a very key AT&T differentiator -- the Apple iPhone.

With all that in mind, it's best to combine comparable company analysis with another valuation technique.

Collecting the cash flow
An alternate way to value a stock is to do what's known as a discounted cash flow (DCF). Basically, this method projects free cash flow over the next 10 years and discounts the tally from each of those years back to what it would be worth today (since a dollar tomorrow is worth less to us than a dollar today).

Because a DCF is based largely on estimates (aka guesses) and it attempts to predict the future, it can be a fickle beast and so its results are best used as guideposts rather than written-in-stone answers sent down from Mount Olympus.

For AT&T's DCF, I used the following assumptions:

2010 Unlevered Free Cash Flow $15.5 billion
FCF Growth 2010-2014 6.4%
FCF Growth 2014-2019 3.2%
Terminal Growth 3.0%
Market Equity as a Percentage of Total Capitalization 71.0%
Cost of Equity 12.0%
Cost of Debt 6.2%
Weighted Average Cost of Capital 9.8%

Source: Capital IQ (a Standard & Poor's company), Yahoo! Finance, author's estimates.

While most of this is pretty standard fare when it comes to DCFs, the academically inclined would probably balk at the way I set the cost of equity. In a "classic" DCF, the cost of equity is set based on an equation that uses beta -- a measure of how volatile a stock is versus the rest of the market -- and a few other numbers I tend to thumb my nose at.

But when you get right down to it, the cost of equity is the rate of return that investors demand to invest in the equity of that company. So I generally set the cost of equity equal to the rate of return that I'd like to see from that stock.

Based on the assumptions above, a simple DCF model spits out a per-share value of roughly $36 for AT&T's stock. This seems to confirm that the stock is currently undervalued.

Do we have a winner?
The valuations that we've done here are pretty simple and, particularly when it comes to the DCF, investors would be well-advised to play with the numbers further before making a final decision on AT&T's stock.

That said, pegging the price right between the two valuation models -- which gives us $34 -- it would seem that we've got a margin of safety pretty close to 20%. Combine that apparent cheap price with the stock's healthy dividend payout and AT&T starts to look like a pretty good buy.

But I'd be remiss not to mention the very obvious risk to AT&T's results. The company hasn't exactly wowed its customers -- a recent Consumer Reports survey ranked AT&T dead last among U.S. mobile service providers -- but it's been able to avoid massive subscriber defections by having the one thing no other carrier has: the iPhone. That won't last forever, though, and it's anybody's guess how AT&T will absorb that blow.

I've got my money where my mouth is on this one, as I own AT&T shares in my personal portfolio. Anecdotally, I've been a very satisfied AT&T subscriber (after many dreadful years with Sprint). And though customers may not be raving to Consumer Reports about AT&T's service, they're also not ranting to the Better Business Bureau about the company. Of the four largest U.S. wireless carriers, AT&T received the fewest BBB complaints over the past year.

AT&T may not be the most exciting stock out there, but with a reasonable price tag and a healthy dividend, I'm content continuing to dial it up in my portfolio.

Want to keep up to date on AT&T? Add it to your watchlist.

Apple is a Motley Fool Stock Advisor choice. The Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer owns shares of AT&T, but does not own shares of any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy assures you no Wookiees were harmed in the making of this article.


Read/Post Comments (4) | Recommend This Article (21)

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 December 16, 2010, at 8:57 PM, railrol wrote:

    In the 1st Table what do the number relate too? Cash, calculated formulas (ie.: P/E) or what? Are smaller or larger numbers numbers considered better?

    (This is similar to all the MoneyFool products: Gains or Losses from inception or whatever, the numbers don't seem to have a corrilation to anything tangable.)

  • Report this Comment On December 23, 2010, at 12:38 AM, mshl726 wrote:

    Hi Matt, Thanks for the analysis. I am new at DCF and trying to follow your assumptions to get to the $36 eq value/shr you calculated. I calculated NPV on 10 years of cashflows totaling $125 bln, and a discounted terminal value of $147 bln and for total equity value of $273bln. Over 5.9bln shares, that gives me equity value of $46/share. Can you let us know if there are any other assumptions you made to get to $36/shr? Thank you.

  • Report this Comment On January 04, 2011, at 11:28 PM, TMFKopp wrote:

    @railrol

    I'm not sure I understand your question...

    The numbers in the first table are valuation multiples.

    Matt

  • Report this Comment On January 04, 2011, at 11:32 PM, TMFKopp wrote:

    @mshl726

    You're most of the way there. Once you have the sum of the discounted cash flows and terminal value though you need to add the net cash (subtract the net debt). In this case, AT&T has roughly $66b in net debt that needs to come off. As far as I can tell, that's the difference between the $46 you came up with and my $36.

    Hope this helps-

    Matt

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