Verizon Communications (VZ -0.73%) is one of the few tech stocks to sport an ultra-high dividend yield. Hovering around 7.6%, it's also quite enticing, as the dividend yield is approaching the long-term return of the broader market.
However, there's more that potential investors should know about Verizon these days -- significant challenges the company has been facing for some time. Investors should have a fuller picture before diving in.
Verizon has grown its free cash flow recently
Verizon is one of North America's top wireless network providers and is often compared to peer AT&T. These two comprise about 75% of the total market, with Verizon capturing about 30% as of first-quarter 2023.
However, this market is not a growth industry. In the second quarter, Verizon's total wireless revenue increased by a mere 3.8% year over year. While many investors would scoff at that growth rate, it's common for telecoms to grow their revenue in the low single digits.
Overall, revenue actually fell by 3.5%, likely because customers put off upgrading their devices to conserve money, and also because of weakness from the business-facing segment. Still, free cash flow (FCF) (probably the most important metric for gauging Verizon's ability to pay a growing dividend) for the first half of 2023 rose 11% to $8 billion.
Why is FCF so important? This measures how much money a company generates from its operations. Because dividends are paid from cash flows, the higher Verizon's FCF pool, the greater a dividend it can pay. It's also crucial in gauging whether Verizon can maintain its dividend. A business shouldn't commit to paying out 100% of FCF because other unknown expenses will pop up.
In the first half of the year, Verizon paid $5.5 billion in dividends, yet brought in $8 billion in FCF. That equates to a payout ratio of 69%, which is relatively safe for a company whose business is extremely reliable. So if Verizon's dividend isn't in danger of being reduced, what's the risk in investing in the stock?
Long-term underperformance is the problem
Just because Verizon pays an extremely reliable 7.6% dividend doesn't mean the underlying asset is increasing in value. Over the past five years, Verizon has paid investors $12.50 per share in dividends. However, the stock price has declined from $51 to $34, losing investors a net $4.50 per share.
Now, let's compare $1,000 invested in the S&P 500 and Nasdaq-100 to see what would have happened over those five years if you had invested your money in those indexes versus Verizon.
VZ Total Return Level data by YCharts
That's dramatic outperformance and illustrates that dividend yield does not indicate future performance. While receiving a dividend check each quarter is nice, it doesn't come close to accounting for the performance you're giving up. I see no reason to think that Verizon can flip a switch and become a perennial outperformer, so investors should avoid the stock.
