Verizon Communications (NYSE: VZ ) has a new financial backer, and it's no less than perhaps the most well-known, most successful investor of all time. Warren Buffett's Berkshire Hathaway disclosed a new investment in the telecommunications giant. Shares of Verizon spiked on the day of the announcement, and it's not hard to see why.
In its regulatory filing with the Securities and Exchange Commission, Berkshire Hathaway revealed it owns 11 million Verizon shares, which amount to a roughly $530 million investment. Buffett is known as a value-investing guru, and on further inspection, it's clear that Verizon displays a host of qualities that make it an ideal choice for the Oracle of Omaha.
Verizon is a cheap stock, generates strong free cash flow, enjoys a strong brand and sizable economic moat, and has a valuable asset in tow after buying out the remainder of Verizon Wireless from Vodafone (NASDAQ: VOD ) .
Read on to discover the motives behind Buffett's purchase, and whether you should follow his lead.
Classic value play
Warren Buffett has long preached the merits of value investing, whereby an investor seeks to calculate a stock's intrinsic value. In other words, the strategy is all about paying $0.50 for $1. Many of Buffett's investments generate strong free cash flows, backed by solid brands, capable management, and an economic moat securing the business from competition. Those benefits are enhanced when you purchase a stock trading at a discount.
Verizon certainly fits the bill on these measures. Providing nationwide cable, Internet, and phone service is an industry nearly impossible for new competition due to the extremely high costs of building out a network. This means that the barriers to entry are very high, which results in a reliable source of profits.
This is evident by Verizon's hefty free cash flow. This is a financial metric that analyzes how much cash a company generates from its underlying operations, deducting money spent on capital expenditures. For example, Verizon racked up more than $22 billion in free cash flow just last year. With this, Verizon is able to send back a lot of cash to its shareholders, primarily in the form of its generous dividend payments.
Verizon distributed nearly $6 billion in dividends to shareholders last year. On a per-share basis, Verizon offers a healthy 4.3% yield. Even better, thanks to the reliability of its business model, Verizon is able to bump up its dividend on an annual basis.
In addition, Verizon has a clear catalyst for continued future growth, thanks to its purchase of Verizon Wireless, and an attractive valuation.
Compelling value opportunity
Last year, Vodafone sold its 45% stake in Verizon Wireless to Verizon Communications for $130 billion. The deal obviously made sense for Verizon, since it now has the advantage of bringing in the remainder of its highly profitable wireless business that it didn't already own. Verizon stated the deal would immediately boost earnings per share by 10%.
Verizon Wireless is an absolute goldmine. It's the largest and most profitable wireless carrier in the United States. In the first quarter, Verizon Wireless increased service revenue by 7.5%, far outperforming the overall company's 4.8% revenue growth. The wireless business should provide plenty of cash flow to support the company's hefty dividend for a long time. Even better, Verizon is fairly cheaply priced, from a valuation perspective.
Verizon generated $4 per share in earnings last year, meaning the stock trades for just 12 times trailing earnings per share. It's off to a good start this year as well; Verizon racked up 23% growth in adjusted EPS in the first quarter.
The key takeaway is that Verizon appears to be a haven for value investors, including the most famous value investor, Warren Buffett. Verizon provides ample free cash flow and returns a large portion of its cash to investors. In addition, the stock is fairly cheap. As a result, it's not surprising to see Buffett take a stake in Verizon, a stock that's got plenty to offer.
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