Part of the reason to own stocks in general is protection from inflation. After all, while a bond's coupon is fixed, a stock's earnings should, hopefully, grow. Ideally, it would be a high-quality company with pricing power, that can either retain pricing and grow, or raise prices without sacrificing customers. That should lead to rising dividends and share repurchases over time.
Verizon (VZ 1.17%) shareholders may have been happy they got an expected annual bump in the company's dividend this month. However, the magnitude of the raise left much to be desired; in fact, it may actually be reason to sell the stock.
Lagging behind inflation
Verizon just announced it would be raising its dividend for the 17th straight year. And while that is a notable milestone, the 1.9% increase wasn't much to write home about, especially following the 1.9% increase from last year.
These figures fall well behind the pace of inflation. U.S. inflation was 8% in 2022, and while it has improved markedly in 2023, the latest consumer price index (CPI) reading still put inflation at 3.7% year over year.
Of course, the past two years have seen outsize inflation. But even the Federal Reserve's long-term target for inflation is 2%, which is still higher than the last couple of dividend increases for the telecom giant.
Why raise the payout at all?
The bigger question might not be why the payout increase is so small, but why Verizon chose to raise it at all, given recent struggles. This may be a case of attempting to satisfy shareholders that have become accustomed to their yearly price increase. After all, if a company stops raising its dividend after 16 consecutive years of doing so, that could lead shareholders to wonder whether the dividend is sustainable at all, and could lead to an even greater sell-off than the 15.5% decline Verizon's stock has seen already this year.
VZ Year to Date Price Returns (Daily) data by YCharts
Verizon's payout ratio currently stands at 53%, so most of its net earnings are already devoted to the dividend. But Verizon has also needed to dip into profits to reinvest in order to stay competitive in the cutthroat telecom industry and service its debt. Of note, last quarter's dividend payment took up an even higher percentage of Verizon's free cash flow, at 68.8%. That's because Verizon's capital expenditures to improve its network exceeded its depreciation, leading to cash flows lower than net income.
In addition, Verizon's debt load stood at $131.4 billion as of last quarter. To the company's credit, it has begun to pay that down slowly, with net debt down by about $4 billion over the past year. But with interest rates now much higher than they were over the past decade, refinancing maturing loans may be more expensive, making debt pay-down more of a necessity.
Growth problems are a big concern
More cash would be available for future dividend increases if Verizon were growing. But the growth picture has been difficult for Verizon in a much more competitive environment.
Unfortunately, there isn't much growth in the telecom industry anymore, with just about everyone having cell phones and mobile plans, leaving existing carriers fighting for market share. For a long time, Verizon had been known to have the superior network, which allowed the company to increase prices unfettered. But with a rejuvenated T-Mobile assuming the network lead in the 5G era as well as better competition and aggressive phone subsidies from AT&T, Verizon has seen consumer defections.
Image source: Verizon.
As you can see, Verizon continues to lose postpaid phone consumers, and business customer growth is decelerating. While fixed wireless broadband is growing nicely, that's a much smaller part of Verizon's revenue base.
The results above led to a 3.5% revenue decline for Verizon last quarter, although services growth did manage to eke out a small 0.8% gain thanks to price increases. Still, that was below the service revenue growth of both AT&T and T-Mobile. And Verizon's operating income declined 4.4%, while both rivals managed to grow profits.
Is Verizon a value trap?
Verizon is raising its dividend; however, the increase seems like window-dressing at this point, lagging behind inflation. Meanwhile, Verizon appears to be losing market share to both of its main rivals in wireless. And the dividend increase, while modest, leaves the company with less cash to reinvest to take on rivals in the current competitive climate.
While Verizon's yield is very high, it still hasn't prevented the stock from giving investors negative total returns when factoring in the stock's decline over the past one, three, and five years. Meanwhile, with higher long-term bond yields these days, investors can get similar yields from corporate bonds, while being safer up the capital structure.
Basically, Verizon seems like it may be a value trap, with bonds being a better bet for yield-seekers from a risk/reward perspective.
