Some investors turned away from stocks recently because of the rising returns in the fixed-income market. A 2-year Treasury note now pays 4.3% (as of Oct. 12), a level that could induce some investors to choose bonds instead of stocks.
However, high-yield dividend stocks such as AT&T (T 2.60%) may still hold some appeal. Due to falling stock prices, AT&T's dividend returns significantly exceed that level. The question for income investors is whether they should take the guaranteed return of the bond or buy AT&T.
The state of AT&T's payout
AT&T may not seem particularly risky at first glance. It is one of only three nationwide 5G providers in the U.S. Since communication is a necessity, this lends itself to a stable business that can support a dividend, as it has for decades.
AT&T's current annual payout of $1.11 per share yields around 7.5% at current stock prices. This significantly exceeds returns paid by Treasuries and will likely induce some investors to generate passive income with this stock.
Nonetheless, this payout cost AT&T more than $5.8 billion in the first half of 2022. Unfortunately, this exceeds the free cash flow of $4.2 billion generated over the same period. AT&T reported $9.2 billion in free cash flow in the same period last year amid lower profits and rising capital expenditures.
Admittedly, the situation is likely not as dire as those numbers imply. Despite lowered free cash flow guidance, AT&T expects to generate around $14 billion in free cash flow for the year. That should cover the cost of the dividend.
There are dividend dangers to consider
Investors should also note that AT&T abandoned a 35-year streak of annual payout hikes in 2021. This is a mixed blessing as AT&T reduced its dividend expenses by nearly $2 billion compared with the same period in 2021. However, maintaining a 5G network is costly, and the company has spent $9.5 billion in the first half of 2022 alone on capital expenditures. Hence, any measure to cut costs should benefit shareholders.
Nonetheless, the annual payout hikes gave its dividend a measure of stability. AT&T held Dividend Aristocrat status until recently, and many income investors were likely staying in the stock for that reason. Following that cut, it has fallen by more than 30% from its 12-month high.
NYSE: T
Key Data Points
Aristocrat status is also significant because it brings payout hikes despite AT&T facing no legal requirement to continue the dividend. With that designation gone, the company now has more leeway to either cut the dividend again or eliminate it completely.
And a heavy debt burden makes another dividend cut possible. The company reduced its debt by divesting its underperforming DirecTV and the business now known as Warner Bros. Discovery. Still, it holds about $136 billion in total debt, a level that may mean the dividend is still in danger.
Should I choose AT&T over the Treasury?
Investors looking for income should probably choose the Treasury note. While AT&T currently offers a much higher cash return, income investing tends not to lend itself to risk. With AT&T's massive debt and capital expenditures, it may need to cut the dividend again so it can reduce its debt.
Admittedly, it is unclear how much it would slash its payout if that were to occur, and a new payout level could still beat a bond return. However, like the last dividend cut, it may negatively impact the stock, increasing the likelihood of a negative return.
