Low-beta stocks are typically less volatile than the broader stock market, making them popular with conservative investors when the market gets bumpy. However, U.S. telecom company Verizon Communications (VZ 0.03%) has had an uncharacteristically bumpy year. Despite a beta of just 0.3, the shares have fallen more than the S&P 500 in this bear market -- down 36% from their high and 24% over the past year.
Verizon's fall isn't completely unmerited, but don't be so quick to write off the stock for next year and beyond. The stock's valuation is pricing in a lot of pessimism, and there are legitimate reasons to be excited instead. Here is what makes Verizon a prime bounce-back candidate moving forward.
Is Verizon being overly punished?
Verizon didn't have a problem-free campaign in 2022. It has been decisively outdone by competitors AT&T and T-Mobile in its core wireless segment. Verizon lost 16,000 wireless customers through the first nine months of 2022. You can see below how the falling share price has steadily punished the stock's valuation throughout the year. But has Mr. Market gone too far?
Verizon's stock has traded at a median price-to-earnings ratio (P/E) of more than 12 over the past decade. Discounting the stock to nearly half its long-term valuation seems harsh, especially when you look at why most people hold Verizon stock in the first place -- that juicy dividend. Verizon's dividend yield is 6.6% today, thanks to a lower share price. The company has paid $8.1 billion in dividends year to date and generated $12.4 billion in free cash flow, a 65% payout ratio.
With a secure and generous dividend, one can look next to growth. Despite the company losing subscribers in 2022, analysts still believe Verizon will grow earnings per share by an average of 4% annually over the next three to five years. That's on par with Verizon's average earnings growth over the past decade.
Can Verizon regain Wall Street's favor?
With a secure dividend and steady earnings growth, there doesn't seem to be a significant factor that justifies a sharp discount on Verizon's valuation. That's OK; sometimes the stock market is irrational, usually more so in the short term than the long term.
So what could give Verizon's stock a lift? Interest rates rapidly rose throughout 2022, which could help explain Verizon's decline. The company carries $148 billion in long-term debt, and rising interest rates make debt more expensive when borrowed or refinanced. So investors should keep an eye on Verizon's interest expenses.
Investors should hope management keeps throwing extra cash at the debt as interest cost Verizon $3.2 billion over the past year, detracting from the bottom line. The company did pay down $1.3 billion between the second and third quarters, though there's a long road ahead.
Fortunately, the debt load shouldn't cause any unexpected turbulence for investors. Verizon is leveraged at 3.2 times EBITDA, which is a little higher than one might like (I look for leverage under 3 times EBITDA). However, it shouldn't threaten the dividend because of the healthy payout ratio.
It will probably keep Verizon from doing anything bold with its balance sheet, which might be a good thing for investors hoping that Verizon remains focused on telecommunications. Keep paying down debt, let the interest saved flow to the bottom line, and perhaps Wall Street will reward the stock with a higher valuation over time.
What does the future hold?
Nobody can know what the market will do next, but a stock's fundamentals dictate where the price heads over time. Verizon isn't likely to ever become a growth stock, but it's a defensive company with a well-funded and high-yielding dividend. The stock's depressed valuation gives investors some cushion for total returns, which could come as the company continues improving its balance sheet.
Until then, a 6.6% dividend yield is a nice consolation prize for holding shares, which is probably why most investors might want to own the stock in the first place. If Verizon can deliver the 4% earnings growth analysts expect, investors could see close to 10% annual returns without even worrying about whether the valuation will rebound. That sounds like a pretty good deal in this turbulent market.