When analyzing a dividend stock, pretty much every piece of advice will tell you to avoid stocks paying higher than a 5% or 6% dividend. This is because the market has dropped the stock's share price significantly due to poor business outlook, which typically requires a dividend cut.
So a red flag goes up when investors see AT&T's (T -0.44%) juicy 7.6% dividend yield. But is AT&T's dividend cause for concern? Or are investors safe to invest in the stock? Let's take a look.
AT&T's reduced expenses boosted the company in Q2
AT&T, the largest mobile carrier in the U.S., also has other ventures like AT&T fiber. However, none of these areas can be considered "growth" industries, as almost everyone in the U.S. can access these products. As a result, any revenue increase is due to capturing market share from another competitor or increasing prices.
That's not a great recipe for growth, but it does provide incremental increases from quarter to quarter. As you can see in the chart below, AT&T's revenue barely squeaked higher in Q2, as it only rose 1%.
Image source: The Motley Fool.
But, when you have a mature company like AT&T, revenue growth isn't as important as what happens beneath the top line. After all, one of the primary reasons to invest in AT&T is its dividend, which is funded after AT&T pays all of its operating expenses and taxes.
Examining AT&T's operating income is a great way to judge its efficiency, as it doesn't include variable one-time charges and taxes. By incrementally decreasing several expense items, AT&T was able to post a blowout quarter, as operating income rose an outstanding 29%.
This ability to execute and become more efficient gives investors more confidence that AT&T's dividend is safe.
The U.S. Treasury bonds may be to blame for AT&T's low stock price
Thanks to various one-time benefits in Q2 2022, AT&T only showed net income growth of 5%, but that's still enough to make most dividend investors happy.
However, none of these business results answer whether AT&T's impressive dividend is safe. A metric called the dividend payout ratio is useful in assessing that. This divides the total dividends paid in the quarter by a profitability metric like free cash flow or net income, thus conveying to investors how much of AT&T's earnings are paid out as dividends.
In Q2, AT&T paid $2.08 billion in dividends to shareholders. On the flip side, it brought in $4.8 billion in net income, giving AT&T a payout ratio of 43%. That's a very healthy number, as investors should only get concerned if this metric rises to above 50% for common companies or 75% if it's a company in a mature and dependable industry like a telecom or utility.
With that in mind, it's safe to say that AT&T's dividend is safe for investors. But why has the yield reached these levels?
While several factors may be at play, one likely has to do with Treasuries yielding a decent amount. When risk-free investments pay nearly 4% for 30 years, and shorter-term notes yield nearly 5%, it entices investors to look for yield in investments other than dividend stocks. Dividend stocks have an underlying asset (the business) that could fail, while Treasuries are backed by the U.S. government, making them more stable. As a result, AT&T's stock was sold off, driving the dividend higher.
When the Federal Reserve decides to reduce interest rates, there will likely be a renewed interest in high dividend-yielding stocks like AT&T, and the stock could see a boost when that happens. However, it's unknown when that will occur so investors will need to be patient. Fortunately, AT&T pays investors a handsome 7.6% dividend yield that is quite safe and can likely be increased as investors wait for this catalyst.
