Verizon Communications (VZ 1.17%) is a leading telecom company that offers investors an extremely high dividend yield of 7.7%. With its share prices down over 40% in just the past three years, to say that Verizon stock hasn't been a good buy of late is a gross understatement.
But that doesn't mean investors should give up on it. Here's why selling the stock right now, at a severely depressed valuation, could be a huge mistake for investors.
The business is still doing alright
Verizon reported its second-quarter earnings numbers last week. For the period ending June 30, sales totaled $32.6 billion. While that was a decline of 3.5% from the prior-year period, the company did report positive signs of growth.
The second quarter was the eighth consecutive period in which the business side reported at least 125,000 postpaid phone net additions. And its core wireless service business, which generated $19.1 billion in revenue, grew at a rate of 3.8% year over year.
Perhaps more important for dividend investors is that Verizon's free cash flow through the first half of 2023 now totals $8 billion, better than the $7.2 billion it reported a year earlier. The company pays out about $2.7 billion in dividends each quarter, so over a six-month period, that's $5.4 billion. That means the free cash flow it is generating right now is more than sufficient to cover its dividend.
The risk around lead-cover cables might be exaggerated
One reason investors have been increasingly bearish on Verizon is that the company might have to spend billions to clean up potentially toxic lead-covered cables. While it is a legitimate concern for investors, it's far too early to tell how much of an obligation that might create for Verizon and other telecom companies.
Estimates from New Street Research say that Verizon's remediation costs could total anywhere between $1.7 billion and $4.1 billion. Even if it does cost Verizon billions of dollars, however, those expenses would likely be spread out over years. That would make them more manageable and lessen the risk that the company would need to stop raising its dividend payments. Its streak currently sits at 16 consecutive years of rate hikes.
Verizon's 7.7% yield might not last for long
Over the past five years, Verizon's dividend yield has normally been below 5%. With the stock now yielding as much as 7.7%, investors might want to consider scooping it up sooner rather than later. When the price of a stock goes down, but the dividend remains intact, the effect is that the yield rises since you need to invest less money to collect the same amount of dividend income.
By waiting, the risk for investors is that if the stock recovers and climbs in value, the yield will drop. Given that the business still looks to be in good shape, it might only be a matter of time before income investors start buying up the stock again.
Plenty of bearishness is priced into the stock
Shares of Verizon currently trade at less than 7 times earnings, which is well below their five-year average of 11. Even if the company were to incur some significant expenses related to lead-covered cables, there's a big margin of safety in the share price right now to factor that in.
Investors have been extremely bearish on the stock, and that makes it an attractive contrarian investment today. There's some risk, but it's not enough to give up on the stock since Verizon's payout ratio is around 50% and the business is still doing well. If the payout ratio were higher, then it would certainly be a stock to avoid, but Verizon is not in nearly enough trouble for investors to be selling off the stock at the rate that they are now.
Given the stock's low valuation and Verizon trading at valuations not seen in over a decade, investors could be making a big mistake by giving up on the stock at this point.
