Although Wall Street is a long-term wealth-creating machine, it can be completely unpredictable over short timelines.
When the year began, the consensus among investors had been that higher inflation and rapidly rising interest rates would lead to an economic slowdown, if not recession. Few analysts were looking for the rebound in the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite to persist. Yet seven months into the year, investors are witnessing one of the strongest performances for the S&P 500 and Nasdaq Composite in modern history.
I count myself among the many investors who had been expecting a weaker environment for corporate earnings in 2023. As a result, I've been sitting on an outsized cash position and have put only a small amount of it to work.
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But amid the 2023 rally, a couple of intriguing opportunities have presented themselves. In particular, an ultra-high-yield dividend stock with a 7.4% yield moved to a historically low valuation in July and offered opportunistic investors, such as myself, the chance to pounce. This was an opportunity I wasn't going to pass up.
This dividend powerhouse hit a 31-year low in July
Although I hold relatively small positions in a handful of ultra-high-yielding income stocks, such as Innovative Industrial Properties and Annaly Capital Management, only two ultra-high-yield dividend stocks individually account for more than 1% of my invested assets: telecom giant AT&T (T 1.02%) and pharmacy chain Walgreens Boots Alliance. AT&T is the ultra-high-yield dividend stock I bought hand over fist in July, which includes common stock and leap options (June 2025 calls with a $13 strike).
In mid-July, shares of AT&T hit a 31-year low. Although telecom stocks provide hearty dividend payments -- AT&T's total return over the past 31 years is far from 0% -- seeing an industry leader's share price effectively go nowhere for more than three decades is a major disappointment.
The culprits for AT&T's poor performance are fourfold.
To begin with, it's a mature company with a low-single-digit organic growth rate that's been left in the dust by high-growth stocks. A period of historically low interest rates following the Great Recession made it easy for investors to overlook perceived-to-be "safe stocks" like AT&T in favor of faster-growing companies.
Another issue for AT&T is the company's outstanding debt, which stood at $137.5 billion, as of March 31, 2023. In addition to high levels of debt constraining AT&T's financial flexibility, a higher interest rate environment could make future projects and refinancings costlier for the company.
The third factor working against AT&T is the successful merger of Sprint and T-Mobile (TMUS -0.06%). As independent telecom service providers, AT&T and Verizon Communications (VZ 1.17%) had well-defined competitive advantages over Sprint and T-Mobile. But following the 2020 merger, T-Mobile's network coverage dramatically improved, and its aggressive pricing strategies have helped bring in new subscribers. In fact, T-Mobile's net postpaid customer additions have regularly outpaced AT&T and Verizon in recent years.
The fourth and final reason AT&T's shares have fallen to levels not seen since early 1993 is due to a recent report published by The Wall Street Journal. The report delved into the financial liability legacy telecom providers might have due to lead-sheathed cables. The uncertainty of potential litigation and environmental costs have weighed on both AT&T and Verizon.
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Here's why I answered the call from this ultra-high-yield dividend stock
With 31 years of tracks in the rearview mirror and no progress made, there would seem to be plenty of reason for investors to give up on AT&T. But during the historic downturn we witnessed on Friday, July 14, and Monday, July 17, I was busy mashing the buy button. While not oblivious to the headwinds facing the company, six catalysts compelled me to act.
First off, telecom companies provide a borderline necessity service. No matter what the U.S. economy throws at consumers, few will be willing to give up their smartphone, wireless access, or internet service during an economic downturn. Persistently low churn rates suggest AT&T's cash flow will remain highly predictable.
The 5G revolution is another reason to have an optimistic outlook on AT&T's stock. It took wireless providers a good decade before they upgraded download speeds from 4G LTE to 5G. Consumers and businesses aren't going to be shy about replacing their wireless devices to take advantage of these faster speeds. This device-replacement cycle should last for years to come and is expected to lead to a sizable uptick in data consumption for AT&T. Data is where the company's wireless division generates its best margins.
In addition to wireless services, broadband demand has been surprisingly strong. AT&T doled out big bucks to acquire mid-band spectrum, which it's used to offer 5G broadband services to its residential and enterprise customers. AT&T Fiber has added at least 1 million net customers in each of the past five years. Best of all, broadband serves as the perfect jumping-off point to encourage high-margin service bundling.
T Total Long Term Debt (Quarterly) data by YCharts.
The fourth reason I took the plunge is AT&T's balance sheet. Though the company's debt load is high, the balance sheet has meaningfully improved since March 2022. In April 2022, AT&T spun off WarnerMedia, which was then merged with Discovery to create an entirely new media entity, Warner Bros. Discovery (WBD -2.17%). When this merger was finalized, it produced an aggregate $40.4 billion windfall for AT&T. This included Warner Bros. Discovery assuming certain lots of debt, as well as paying cash to AT&T. Between March 31, 2022 and March 31, 2023, AT&T's total debt declined from $207.6 billion to $137.5 billion. Meanwhile, net debt dropped from $169 billion to $134.7 billion, which provides additional flexibility for AT&T to sustain its supercharged 7.4% yield.
The fear regarding lead-sheathed cables serves as the fifth upside catalyst for AT&T stock. Even if AT&T has some form of financial liability, it would likely be many years before that's finalized in court. Additionally, the cost to replace/remove lead-sheathed cables is probably much lower than the shock-value estimate of $59 billion for the industry, which was provided by analysts at New Street Research.
The sixth catalyst that compelled me to buy common stock in AT&T, as well as June 2025 leap options, is its valuation. As of July 17, AT&T was valued at roughly 5 times Wall Street's consensus earnings for the current and upcoming year, which is historically cheap, even for telecom stocks.
Data from sell-side consultancy firm Yardeni Research shows that integrated telecom service providers (e.g., AT&T and Verizon) traded at a forward price-to-earnings (P/E) ratio of between 10 and 20 for almost the entirety of the 26-year period from the start of 1995 through 2020. The current forward P/E of 6.8 for the industry, and the even lower forward P/E of roughly 5 for AT&T, is nothing short of a steal for patient investors.
