High-yield dividend stocks can be a great way to grow your capital. Thanks to the power of compounding, stocks that offer above-average dividends often produce returns on capital that beat the market over long periods. However, these stocks can also be dangerous value traps. Abnormally high yields are often the result of a rapid downturn in a company's share price resulting from a deteriorating fundamental picture.
Telecom giants AT&T (T -0.47%) and Verizon Communications (VZ -0.72%) are prime examples of this phenomenon. Both companies have seen a sharp decline in their share prices in 2023 over concerns over their debt-laden balance sheets, the emergence of leaner competitors, and a less-than-stellar macroeconomic outlook. As a result of this steady decline, AT&T's stock now pays out an annualized yield of 7.12%. Similarly, Verizon's yield has ballooned to 7.28% this year.
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Here's why savvy investors might want to buy these two high yielders on the dip.
AT&T: A falling knife worth catching
AT&T's stock price has fallen by 25.7% over the past 12 months and is currently trading close to its 52-week low. The company's stock price has dropped for several reasons.
First, AT&T is deeply in debt because of an ill-advised expansion into entertainment through the acquisitions of WarnerMedia and DirecTV, coupled with its aggressive buildout in 5G and fiber. Highly leveraged companies like AT&T have struggled in the current era of high-interest rates.
Second, AT&T's free cash flow (FCF) came in well below expectations during the first quarter of the year. Although management still expects to hit its $16 billion FCF target for 2023 because of lower anticipated expenses in the second half of the year, AT&T's hefty dividend will hang in the balance until this forecast rings true. After all, the telecom giant can ill-afford a major drop in FCF with a trailing-12-month payout ratio of nearly 56%.
Lastly, AT&T is essentially a pure-play income stock at this point. The emergence of low-cost wireless options, along with competition from industry heavyweights like T-Mobile and Verizon, are expected to significantly curtail AT&T's near-term growth prospects.
However, there are reasons AT&T stock is still attractive. At 6.4 times forward earnings, AT&T stock hasn't been this cheap since the height of the 2022 bear market. What's more, the company's impressive scale and growing presence in 5G/fiber should allow it to maintain a top-tier market share for the foreseeable future.
Finally, AT&T is unlikely to dramatically reduce its dividend payment even if FCF comes in light for the year. Management is well aware that a large contingent of shareholders owns the stock solely for its income potential.
Verizon: Buy the dip
Verizon's stock has lost nearly 30% of its value over the past 12 months and is currently trading close to its 52-week low. The company's stock price has been pulled down by industry-specific headwinds. Chief among them is the emergence of rival carriers like T-Mobile. Wireless tech has enabled competitors to ramp up in terms of scale and overall quality in record time.
However, there are solid reasons to buy Verizon's stock. Firstly, Verizon's shares are downright cheap from a historical perspective. At 7 times earnings, the company's stock is trading close to a four-year low on this key valuation metric. In addition, the company's highly coveted dividend is well covered by FCF. Underscoring this point, Verizon used less than a third of its FCF from operations to pay dividends in 2022.
Lastly, Verizon is likely to maintain its position as the top dog in the U.S. wireless carrier space. The company has built a top 5G wireless network, strong brand loyalty among subscribers, and the largest customer base among wireless customers in the United States. In turn, Verizon should be able to retain an outsized share of the U.S. telecom market in the years ahead.
All told, Verizon's attractive valuation and sky-high yield make its stock a top buy.
