Investors can often overlook huge technological shifts that are right in front of them in search of the next big thing. One such example is 5G connectivity. Perhaps many are fooled by commercials that trumpet the arrival of 5G, but make no mistake, we're still in the early phases of adoption and wise investors can position themselves for success.
Although consumers are now able to take advantage of faster connection speeds, the real breakthrough will occur as the Internet of Things (IoT) gains even more steam. It is expected that connected devices will more than double between 2020 and 2025, growing from 31 billion to 75 billion. We've already seen the potential for IoT with autonomous vehicles and artificial intelligence, and without reliable networks capable of processing commands at lightning-fast speeds, the IoT cannot exist.
Despite the opportunity, investors continue to overlook this critical part of the fast-growing IoT ecosystem. Find out why Verizon Communications (VZ -4.91%), AT&T (T -5.00%), and the Pacer Benchmark Data and Infrastructure ETF (SRVR 1.11%) should be on income investor's radars.
AT&T is improving its balance sheet
You can't address AT&T without discussing its massive dividend. Currently, shares yield approximately 7%. Unfortunately, that's been the only return for investors over the past five years. In that period, the stock price is down approximately 20% due to concerns about its enormous debt pile.
The issue isn't AT&T's mobility segment (wireless). The company went on a debt-fueled buying spree to forcefully enter the television industry, buying DIRECTV for $49 billion in 2015 and Time Warner for $86 billion in 2018. Both were struggling before the pandemic, but COVID-19 has led to further deterioration.
AT&T is looking for ways to improve the balance sheet, including putting DIRECTV on the sales block, while ensuring it's investing to build out its 5G network. The company guided for free cash flow in 2020 to exceed $26 billion, nearly double the annual dividend payout of $15 billion. The free cash flow guidance includes $20 billion for capital expenditures. Outside of any unforeseen developments, this dividend is safe.
In the end, AT&T will need to continue to monetize its 5G capability. In 2017, AT&T had a big win when it was selected by the First Responder Network Authority (FirstNet) to build a network for first responders, and quickly moved to create a prioritized 5G experience for FirstNet. It's starting to bear fruit with more than 14,000 public safety entities and more than 1.7 million connections.
Verizon's dividend is safe as well
With a dividend yield currently at 4.2%, Verizon's yield is nearly half of AT&T's. Part of this is due to better stock performance: Verizon shares have increased 25% over the last five years. It's true Verizon also has a large debt pile, but unlike AT&T, which spent money to acquire new businesses, Verizon was purchasing something more important: itself.
Verizon's wireless division was initially a joint venture with British telecom Vodafone before anybody knew how important the technology would become. By the time Verizon decided to buy out Vodafone's stake in 2013, the $130 billion price tag required the largest debt issuance ever. The deal was immediately accretive to earnings and freed Verizon to build out its top-notch 5G without having to deal with minority ownership.
Verizon can easily support its dividend, as its free cash flow payout ratio was 56% in 2019, and it continues to invest heavily in its 5G network, particularly to build out its lightning-fast 5G ultra wideband coverage. Increasingly, the company is looking for ways to monetize its 5G network. Recently, Verizon Business announced its IoT Managed Services offering to help enterprise customers better deploy their IoT capabilities.
This below-the-radar ETF is primed for dividend growth
The last investment isn't a stock, but rather the Pacer Benchmark Data and Infrastructure ETF. Pacer's ETF is comprised of real estate investment trusts, or REITS, that focus on the telecommunications infrastructure space. Many income investors favor REITS as they are required to pay out 90% of their taxable earnings as dividends.
To quickly scale deployment, 5G network providers like AT&T and Verizon will often lease cellphone towers from third parties, creating a reliable stream of income for those third parties. The two largest cellphone tower REITS -- Crown Castle International and American Tower Corporation -- comprise nearly 30% of the Pacer ETF.
Although the ETF's 1.6% yield seems minuscule compared to Verizon's and AT&T's, it will only continue to grow as demand for 5G connectivity requires more cellphone towers. And make no mistake, this is happening. According to global research firm Gartner, spending on 5G network infrastructure grew to $8.1 billion in 2020, an increase of 96% from the prior year. Spending on 5G buildout will only continue to increase now the smartphone upgrade cycle is increasingly comprised of 5G-compatible units.
There are risks. Unlike stocks, ETFs have ongoing annual expenses that eat into returns. At 0.60%, Pacer's expense ratio is higher than many broad-based indexed ETFs. Investors should also note this is considered a non-diversified ETF as more than 75% of its total portfolio is in its top-10 holdings. Despite the drawbacks, the Pacer Benchmark Data and Infrastructure ETF might be the best way for dividend-growth investors to take advantage of the next generation of wireless connectivity.
Get paid to wait for the next big thing
Yes 5G connectivity has arrived, but we're only in the beginning stages of adoption and monetization. 5G is more than fast videos and gaming, instead it will further the nascent "Fourth Revolution," an increase in IoT and next-gen applications like self-driving cars and smart cities. Even if this trend takes longer than anticipated, you'd be well-paid for your time invested in these companies via dividends. Smart investors can position themselves for immediate income and decades of growth by owning these three investments.