Not a lot of consumers are shopping around for a new wireless carrier these days, but if you're looking to invest in one, Verizon Communications (VZ 0.60%) and T-Mobile US (TMUS 0.43%) are your two best options. Both carriers have consistently added valuable postpaid subscribers during a period of fierce competition among the four major wireless service providers. And while T-Mobile is a pure-play wireless carrier, Verizon offers more diversity with its wireline and digital media/advertising businesses.
Here are a few things for investors to consider when determining which is a better buy.
Over the last 12 months, Verizon and T-Mobile have each added around the same number of postpaid connections -- a bit over 4 million. Postpaid subscribers pay their bill after the service has been rendered, are more creditworthy, and are generally considered more valuable.
But where Verizon's growth generally stems from tablets and connected devices, more than 3 million of T-Mobile's postpaid additions were phone subscribers. Phone subscribers are much more valuable than tablet or connected device customers, as they produce higher average revenue.
T-Mobile is exhibiting the fastest growth in postpaid phone subscribers of any wireless carrier. Last year, it took over 100% of postpaid phone net additions in the industry. While net additions have slowed down in 2016 compared to last year, they're still way ahead of Verizon. Verizon's net additions have slowed down as well as the market saturates and subscribers switch less often.
Verizon's sticky customers
Although T-Mobile is growing its postpaid phone subscriber base at a faster clip than Verizon, Verizon's customers tend to be stickier and more valuable. Verizon's average revenue per connection is $48.04, which is higher than T-Mobile's average revenue per postpaid phone subscriber of $46.67. Keep in mind, Verizon's number includes its tablets and connected devices connections as well, which produce less revenue per connection.
Verizon's churn rate is significantly lower than T-Mobile's, coming in at 0.94% compared to 1.27% for T-Mobile's phone customers. Verizon's churn rate is also negatively impacted by a free tablet promotion it ran two years ago.
Verizon benefits from a lot of accounts supporting multiple devices, indicative of family plans. Family plans are the least likely to switch carriers as they require coordination among multiple users. As of the end of the second quarter, Verizon had 3.02 connections per account. T-Mobile had just 2.64 customers per account, and it's added 0.21 customers per account over the trailing 12 months.
A look at valuation
T-Mobile is certainly priced for growth with a P/E ratio floating around 36. Verizon, by comparison, is priced at less than 15 times its trailing-12-month earnings.
Indeed, analysts are expecting a big jump in earnings from T-Mobile next year, and if you compare earnings ratios based on 2017 earnings expectations, the gap closes quite a bit. T-Mobile's 2017 P/E ratio is about 23, while Verizon trades for 13 times estimates for next year.
Verizon's sticky customer base provides strong cash flow, though, producing $15.4 billion in free cash flow over the trailing twelve months. For reference, T-Mobile's free cash flow was $1.61 billion in the same period.
Verizon's free cash flow allows it to support its dividend and continually increase it year after year. Verizon's management has increased its dividend for nine straight years, with an average increase of 2% to 3% over the last few years. Still, its dividend payout ratio is a manageable 63%, making it an attractive option for dividend growth investors.
Investors looking for growth and a pure play in the U.S. wireless industry should buy T-Mobile. It's by far the fastest-growing carrier and it's investing heavily to continue growing more than the competition. That means it's unlikely to start paying a dividend anytime soon, but investors could reap the benefits of capital gains.
The matter of which is a better buy really depends on your portfolio strategy. If you're in growth mode, T-Mobile likely fits your needs. If you're looking to round out a dividend portfolio with a telecom company, no other telecom provides a better dividend than Verizon.