The telecommunications sector is a haven for dividend investors. This isn't surprising, of course, because telecoms like Verizon Communications (VZ -4.67%) and AT&T (T -1.21%) display all the typical credentials of big dividend payers. They both operate large businesses that generate lots of free cash flow, which allows them to sport very high dividend yields.
Here's a rundown of the sustainability of Verizon's and AT&T's hefty dividend yields, including which of the two telecom giants is the better stock to buy right now.
Verizon and AT&T square off
Verizon and AT&T are currently the two highest-yielding stocks in the Dow Jones Industrial Average. Not surprisingly, they're often an early stop as investors look in search of yield. Here's how the two compare in some critical dividend metrics.
As you can see, while AT&T has the edge in terms of current yield, Verizon's growth and free cash flow metrics are better. Verizon generated $6.3 billion of free cash flow over the first six months of the year, thanks in large part to its hugely successful wireless business. Wireless operating revenue is up 7% through the first half, year over year, which was better than the overall company's 5% revenue growth. Margins are improving as well, which resulted in 9% growth in wireless earnings before interest, taxes, depreciation, and amortization (EBITDA) in the same period.
Now that Verizon has complete control of Verizon Wireless after having purchased the remaining 45% stake, future cash flows should keep growing at strong rates.
To be sure, AT&T is growing as well, just not as fast as Verizon. AT&T generated 2% revenue growth over the first six months. Like Verizon, AT&T's wireless segment is carrying most of the weight. However, AT&T's earnings per share are flat through the first half because of higher operating costs. This has weighed on its cash flow generation. AT&T's free cash flow totaled $5.2 billion in the first two quarters of the year, and it paid out almost all of it to investors as a dividend. This will significantly hamper the company's ability to increase its dividend significantly beyond its current level.
AT&T management expects 5% revenue growth along with mid-single-digit earnings grown on a percentage basis, for the full year. While that is a notable forecast, it's hard to see how the company will get there based on its performance over the first half.
AT&T has the higher yield, Verizon has the higher growth
Picking between AT&T and Verizon could come down to which type of investor you are. For those who need current income, such as those in or nearing retirement, AT&T could be the way to go as its 5.25% yield is meaningfully higher than Verizon's 4.4% yield.
For those with a longer time horizon, Verizon is the better pick. That's because it's growing earnings much faster than AT&T and carries a lower payout ratio as well, which means it's got better dividend growth prospects. Verizon's five-year compound annual dividend growth rate is double AT&T's.
AT&T's high dividend yield is sufficiently protected by cash flow, and it expects earnings growth this year, which will further boost its dividend protection. But it's almost distributed all of its free cash flow so far this year, which leaves limited room for future dividend hikes. By contrast, Verizon has a much more comfortable free cash flow payout ratio, which should provide investors with higher dividend growth rates in the future.
With enough time, the income that investors receive from ownership of Verizon stock should catch up based on the higher dividend growth. But for income needs right now, there's nothing wrong with AT&T.
