Dividends have long served as a vehicle for stock stability. Many investors appreciate such cash flows, and when companies have dividend obligations, it tends to minimize the trading instability that leads to extreme stock price swings. However, business conditions can change, creating situations where longtime dividend stocks are increasingly unable to fund their payout obligations.
On the other hand, there are situations where one-time growth companies become cash rich as they mature and attain a level where it would seem they can easily afford such payouts. Such a move would not only enrich shareholders over the long term but also provide the foundations to maintain company stability over time.
Let's look at a couple of examples of both scenarios and see what they might mean for potential investors.
2 companies that should eliminate their payouts
Admittedly, the idea that AT&T (T 1.02%) and Verizon (VZ 1.17%) should eliminate dividends might provoke shock and anger among many investors. These companies have paid dividends since the original AT&T was split into several regional holding companies way back in 1984.
That anger would come partly from the fact that both companies currently offer yields of 7%, which look pleasing to dividend investors.
Data by YCharts.
Those yields became so high because the price of both stocks has trended downward for years. The high cost of nationwide 5G networks and buying the wireless spectrum to support the networks took a toll on both companies. There is also the fact that AT&T lost billions on disappointing merger deals that eventually led the company to sell off its share of DirecTV and what is now Warner Bros. Discovery. The most recent spinoff even prompted a dividend cut in 2022.
AT&T brought in $43 billion from the Warner Bros. Discovery spinoff. But even with that influx of cash, it is still managing a total debt load of $137.5 billion. During the first quarter, it generated free cash flow of only $1 billion, even as it spent over $4 billion on capital expenditures (capex) and had to defer $2 billion of its almost $4 billion in dividend obligations.
Verizon is managing about $153 billion in debt. It seems somewhat better off than AT&T, as it generated over $2 billion in free cash flow in its most recent reported quarter. That was left after it spent over $6 billion in capex and just under $3 billion in quarterly dividend costs.
Nonetheless, both companies would have had significantly higher free cash flows were it not for their dividend payouts. That cash flow could have been used to reduce debts and bring more stability to their balance sheets and lessen the threat of falling behind technologically.
It could also make them more competitive with their peer T-Mobile, which has saved itself billions over the years by not offering a dividend.
So, which companies should pay dividends?
Alphabet (GOOGL 10.22%) (GOOG 9.96%) and Amazon (AMZN 3.43%) stand in stark contrast to the telcos. They are two of the top-performing stocks of the 21st century, delivering massive long-term stock price gains for investors.
Their growth hinged, in part, on having massive cash positions driven by years of strong cash flows. Alphabet now claims $115 billion in liquidity. In the first quarter alone, it generated $17 billion in free cash flow. And this was despite a lagging performance in its digital ad business and more than $6 billion in property and equipment spending.
Likewise, Amazon stock has suffered as e-commerce activity plateaued and growth in its Amazon Web Services segment slowed modestly. It holds around $64 billion in liquidity.
Amazon's history of investing heavily in itself means its free-cash-flow situation differs from that of Alphabet. The e-commerce leader reported negative free cash flow of over $3 billion in the first quarter after it had over $14 billion in property and equipment spending, levels that might make it appear unwise to pay a dividend.
However, such investment-related spending has historically increased free cash flow over the long run. And with Amazon's market cap exceeding $1.3 trillion, its retail business could soon reach a maturity stage that will mean slower growth. Hence, it will likely be making fewer such investments in the future.
Moreover, both stocks have underperformed the S&P 500 over the last year. And despite the companies' massive size, their shares suffered significant sell-offs in the 2022 bear market. Hence, a dividend might help restore some investor confidence. It would also draw the interest of income investors, who could help bid shares higher -- which could make dividend payments worthwhile.
Finding the right dividend level
Paying dividends tends to bolster stability and investor confidence in a stock. This made payouts popular with mature companies, while growth stocks tend to avoid them.
However, the economics of companies and their stocks can change over time. With the massive capex and debt costs of the telcos, it appears they can no longer afford their payouts. Conversely, Alphabet and Amazon have grown into mature companies with massive cash hoards. This means they can likely afford a dividend and might draw more investors to their stocks with such a move.
