Better Buy: Verizon vs. AT&T

Depending on your investment goals, dividends may or may not be a huge factor in which stocks you purchase. Dividends can be powerful tools for investors, particularly for those approaching or in retirement, as they provide steady cash flow streams that may allow them to avoid selling stocks to raise cash at inopportune times.

When building an income-focused portfolio, you may be tempted to sort potential stock picks by their dividend yields. Verizon (VZ 2.85%) and AT&T (T 1.17%) will appear fairly high up on such filtered lists. But which of these high-yielding telecoms is the better buy now? Or should income investors keep shopping?

AT&T's spinoffs have improved its financials

These businesses need no introduction, as they are two of the largest phone carriers in the U.S. Each also has a business and consumer internet segment. In the U.S., these areas aren't considered growth industries because they are fairly saturated markets.

According to Pew Research, as of 2021, 95% of American adults have cellphones, 85% have smartphones, and 77% of homes have access to broadband internet. And the market has been near saturation for a while -- even in 2014, around 91% of U.S. adults had cellphones.

This is reflected in both companies' results over the past decade, as their revenue growth hasn't been anything special.

VZ Revenue (Quarterly YoY Growth) data by YCharts.

The peaks and valleys in AT&T's revenue coincide with its acquisitions and spinoffs of DirecTV and Time Warner, but the overall trend has been for fairly low growth.

While stock performance over the short term can be influenced by a host of factors, over the long term, gains are powered by one thing: earnings growth. For companies with minimal revenue growth, the only way to grow earnings substantially is to become more efficient. Verizon's operating margins have remained relatively steady over the past five years, while AT&T's have risen substantially recently thanks to its decisions to spin off DirecTV and Time Warner.

VZ Operating Margin (TTM) data by YCharts.

From a pure business standpoint, AT&T is improving its financials, but still hasn't matched Verizon's margins. But what about the dividend yield?

Both companies have been disappointing performers historically

From a dividend perspective, Verizon's payout is juicier than AT&T's, but only slightly, with the stocks yielding 6.9% and 6.5%, respectively. That's a handsome payout, but is it sustainable?

The dividend payout ratio weighs how much a company pays in dividends against some sort of cash flow metric, be it earnings or free cash flow. Because free cash flow (FCF) is a better metric for how a business is doing from a cash-in, cash-out perspective, I'll use it.

Data source: YCharts. TTM = trailing 12 months.

Verizon's ratio is butting up against its ceiling, giving it relatively little wiggle room should a recession strike. On the other hand, AT&T's ratio gives it room to sustainably grow its dividend each year.

But as much as income investors may be focused on dividend yields and payout growth potential, total return on investment is a metric that can't be ignored. And while AT&T has been beating Verizon on that score, neither stock has done well at all compared to the market.

Data source: YCharts.

Those figures include dividend reinvestment. Over nearly every time frame in the past decade, Verizon and AT&T have been terrible underperformers.

So as for which of these telecom giants is the better buy, I'd say neither, because there are better alternatives. That's not to say all dividend-paying companies are bad investments, but AT&T and Verizon haven't been great ones historically, which is why I think investors should look elsewhere.