High-yield dividend stocks can be a great way to build wealth over time. These stocks offer returns that often outperform the broader market, thanks to the power of compounding interest.
However, the tantalizing value proposition of some high-yield stocks can also be a mirage. Mouthwatering yields are often a sign that a company's fundamentals are on shaky ground, and its dividend is unsustainable.
AT&T (T 1.02%) and Devon Energy (DVN 0.19%) are prime examples of this fundamental problem with high-yield dividend stocks. Both companies have seen a sharp decline in their share prices in 2023 over balance sheet, competitive, and macroeconomic concerns.
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In turn, AT&T's annualized dividend yield has ballooned to over 7% this year. Similarly, Devon Energy's yield has swelled to 10.4% over the past 12 months (more on that later). Both companies have attempted to calm anxious shareholders, but their efforts haven't translated into much of a positive change from a share price performance perspective.
So which of these high-yield dividend stocks is the better buy right now?
The case for AT&T
AT&T's stock holds the potential to be a passive-income powerhouse, but challenges do exist. AT&T's shares have been weighed down by its debt-laden balance sheet ($137 billion in total debt as of March 31), its ongoing restructuring and cost-savings plan, the emergence of low-priced competitors, concerns about an economic slowdown leading to a rise in customer delinquencies, and its less-than-ideal image as a legacy telecom anchored to antiquated technology.
While some of these criticisms are indeed valid, AT&T has evolved with the times, resulting in a leading market share in rapidly growing segments like fiber. What's more, the company has done an admirable job of quickly delevering its balance sheet. AT&T exited the first quarter of 2022 with over $169 billion in net debt (total debt less cash and cash equivalents). By the end of 2023, management thinks net debt will fall to around $128 billion.
Additionally, AT&T isn't a dinosaur. The company's heavy investments in 5G and fiber put it on the cutting edge of the industry's innovation curve. Moreover, AT&T is experimenting with artificial intelligence-derived solutions via a collaboration with Nvidia to improve fleet dispatches. The telecom is also tinkering with AI-based customer care solutions, which could lead to additional cost savings down the line.
What about the dividend? Although some concern does exist among shareholders that AT&T won't be able to cover its dividend in 2023, management thinks otherwise. Free cash flow (FCF) is expected to ramp over the course of the year to $16 billion or more.
If this happens, AT&T will have no problem covering its roughly $8 billion in annual dividend payments to holders of its common stock. However, management's forecast does seem to hinge on FCF more than quadrupling in the last six months of 2023.
On a positive note, AT&T stock is attractively priced. At 6.6 times projected earnings, the telecom giant's shares are trading at a steep discount relative to historical norms. Hence, the market may have gotten overly bearish on this top dividend stock, depending on what happens on the FCF generation front.
The case for Devon Energy
Devon Energy is a U.S.-based energy company with a focus on onshore drilling. It has a leading position in some of the most productive shale basins in the country, such as the Anadarko Basin, Delaware Basin, Powder River Basin, Williston Basin, and Eagle Ford.
These basins have enabled Devon to achieve high well performance and low production costs in recent years. For example, in the first quarter of 2023, the company reached a record production level of 320,000 barrels of oil per day.
Why should investors consider Devon? Besides its operational excellence and low-risk production assets, Devon offers a compelling valuation and generous dividend yield. In terms of valuation, the company's stock is trading at 7.29 times its expected earnings. For comparison, the average multiple among its peers is 8.34, implying Devon's shares are undervalued.
Devon's dividend program operates on a fixed-plus-variable framework. The variable component is tied to the company's quarterly FCF. At current levels, Devon's stock sports a trailing-12-month dividend yield of 10.4%. The oil company's yield is substantially higher than the 1.66% average among S&P 500 stocks, as well as AT&T's.
Moreover, there is a possibility that oil prices may rise sharply in the second half of the year, which could lead to higher quarterly FCFs and larger dividend payments for shareholders.
So which is the better buy?
In this head-to-head matchup, Devon Energy is arguably the better play for income investors. Devon's shares are undervalued relative to its mid-cap energy peers, and the potential for oil prices to rise in the second half of 2023 bodes well for its fixed-plus-variable program. AT&T, on the other hand, may have a tough time reaching its $16 billion-plus FCF flow target for 2023. Devon does not face a similar overhang, making its shares a more compelling buy right now.
