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For those looking to pad their retirement accounts with solid dividend payers, the sight of Verizon's (VZ +1.80%) dividend seems too good to be true. A 4.5% yield from an industry leader trading for a 50% discount to the broader market? Yes, please!
But as you'll see below, it's worth digging in to see if all that glitters really is gold before putting your hard-earned cash behind the company.
The most important thing
For dividend investors, the most important thing to continually evaluate is a company's free cash flow (FCF) statement. This represents the amount of cash an organization can put in its pocket by running its business, minus any capital expenditures. At the end of the day, it is from FCF that healthy companies pay their dividends -- and as the FCF trends change, so too do a company's dividend policies.
This is where I ran into something somewhat concerning. Over the past 12 months, Verizon has brought in $11.5 billion in FCF. There's nothing wrong with that. But in order to pay its dividend, the company used 80% of FCF. While that's technically sustainable, it raises two red flags: (1) If the company meets tough times, maintaining the dividend may be difficult, and (2) even if it doesn't encounter difficulties, Verizon may not be able to grow its dividend substantially moving forward.
But by digging deeper, we can see this might be a bit more of an anomaly than a trend. In June of this year, Verizon ratified its collective bargaining agreement with employees. Because of that, Verizon "recorded ... charges of approximately $3.6 billion." That's a huge one-time charge, and it showed up in the company's bottom line and on the FCF statement.
While it's definitely important to note such a big charge, it's also worth asking if this is something that long-term investors should really be worried about.
Where does the company really stand?
To get a better idea of the trends at Verizon, I suggest investors back up and look at the company's history of FCF and dividend payments over the past decade. When we do that, here's what we see:
Data source: SEC filings.
Viewed through this lens, there are a couple of things that stand out. First, while the trend is certainly not linear, FCF has undoubtedly trended upwards over the past decade -- increasing an average of 12% per year. Second, the dividend is historically very safe, with 2005 being the only year where the payout ratio from FCF eclipsed even 65%.
The bottom line: Verizon's dividend is pretty safe.
Some other things to consider
Before giving my full-fledged support to Verizon, there are a few other caveats worth considering. First and foremost, while the company is the largest mobile provider in America, the telecom landscape is not what it used to be.
Verizon, sensing that disruption and innovation are rampant in today's technological setting, has branched out into other lines of business. That's evident through the company's acquisition of AOL and the announced plan to buy Yahoo!'s core operating business. I wouldn't be surprised to see the company continue to trend toward other strategic initiatives.
What investors need to watch is whether or not those moves materially affect Verizon's cash flow statement. If they do, then there may be cause for concern regarding the company's dividend. If not, however, I have no problem endorsing Verizon's fat 4.5% payout as a safe and sustainable one.
