Dow Falls 1% as Investors Flee Risk; but Verizon, AT&T Hold Their Own

Even though the Dow plunged for a second straight day Thursday, the Dow's telecom stocks did relatively well.

May 15, 2014 at 9:05PM

The Dow Jones Industrials (DJINDICES:^DJI) dropped 167 points, or about 1%, on Thursday, with retail earnings providing one of the catalysts for the Dow to extend its losses from yesterday. In addition, conflicting reports on the economy led to uncertainty among investors about whether the sluggish recovery will continue at its current pace or give way to growth headwinds that could slow its advance even further. In a sea of red, only AT&T (NYSE:T) and one other Dow component rose, but AT&T rival Verizon (NYSE:VZ) managed to minimize its losses on a tough day for the broader market, falling just 0.1%.

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How investors look at telecom stocks
Historically, investors viewed AT&T, Verizon, and other telecom stocks in much the same way they would consider traditional electric and gas utilities. In essence, the business models they had were similar: telecoms and utilities made large upfront capital expenditures to build out their distribution networks, and then they relied on regulated rate environments to recoup those capital costs gradually over time and guarantee a modest, but adequate, profit. Everyone needed a phone just like they needed electricity and other utility services, and so AT&T and Verizon could count on their landline base to support the expenses of upkeep, and leave plenty of extra cash flow for dividends and buybacks.

Nowadays, Verizon and AT&T still have that perception to some extent. Many subscribers view smartphones as necessary to their lives, and they're willing to pay higher monthly payments that the two telecom giants then use to recoup the costs of setting up their wireless networks, retiring debt, and ensuring a fair profit.

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As a result, telecom stocks are often tied to interest rates and the bond market. When bonds soar, as they did today, then AT&T and Verizon can often do better than the Dow Jones Industrials as a whole. When bonds do poorly, though, the telecoms don't hold up nearly as well as the Dow and other stock-market benchmarks.

Is growth coming?
But more recently, investors have also looked at Verizon and AT&T from a growth standpoint, as well. When you consider how far the wireless industry has come in just the past decade, it's easy to understand why the two telecoms have so much potential to grow. In particular, as more people gain access to mobile devices, AT&T and Verizon will have opportunities to woo those new customers to their networks, boosting subscriber growth.

At the same time, though, those growth opportunities could fall prey to competitive pressures. For the most part, AT&T and Verizon haven't been aggressively confrontational against each other, seeming content to split the market between the two of them. But up-and-coming smaller wireless networks have aggressively fought the two Dow telecom giants on price. If price wars erupt and stick around for a while, then even subscriber growth might prove insufficient to offset falling margins.

For now, investors appear to favor the income approach at valuing the two telecom giants of the Dow Jones Industrials. That should bode well for AT&T and Verizon, as long as the bond market cooperates.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. The Motley Fool has a disclosure policy.

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