Many stock analysts entered 2024 with the expectation that the year would mark a shift to value. After all, large-cap growth stocks had a stellar performance last year and many of them are now trading at lofty valuations that are hard to justify.
On the other hand, many solid but slower-growth companies have seen their share prices decline in recent years due to rising interest rates and a cooling economy. Moreover, investors should not forget that value stocks have often beaten growth stocks over long periods, and a reversal of fortune could be on the horizon given that growth stocks have been the market's best performers since around 2007.
With this background in mind, AT&T (T 1.02%) stands out in many ways as a highly attractive value play that could benefit from a possible sea change in sentiment. In the same breath, this telecom giant also comes with some important risks that might keep it from participating in a marketwide value tilt in 2024.
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Is AT&T stock a value stock or a value trap? Let's dig deeper to find out.
Reasons to buy
First, AT&T is trading at an exceptionally low forward-looking price-to-earnings ratio of less than 7, while the average telecom stock has a multiple of 14.5 and the average S&P 500 stock trades at 21.4 times projected earnings. AT&T stock thus appears undervalued compared to its peers and the market as a whole. If the market shifts to favor value stocks, AT&T could see significant upside.
Second, AT&T offers a generous dividend yield of 6.66%, which is much higher than the average yield of short-term government bonds (4.8%), telecom stocks (4.65%), and S&P 500 stocks (1.84%). This means that AT&T can provide you with a steady income stream that beats most alternatives. Moreover, dividend stocks have historically outperformed the broader market, although the highest yielders tend to lag behind the S&P 500.
Third, AT&T's dividend is well supported by its financial performance. Its payout ratio is 55.8%, which means that it only pays out slightly more than half of its earnings as dividends. It also has a modestly growing top line and improving free cash flows, both of which are essential for maintaining and growing a dividend. Unless there is a severe economic downturn that affects its customer base, AT&T should be able to sustain its dividend for the foreseeable future.
Reasons to stay on the sidelines
One of the main reasons why AT&T's stock is trading at a low valuation is its high debt-to-equity ratio of 135%. This indicates that the company relies heavily on borrowed funds to finance its operations and investments. Although this is common in the telecom sector, where the average debt-to-equity ratio is 149%, investors are worried about AT&T's ability to reduce its debt while also expanding its network and maintaining a generous dividend payout.
Another reason why AT&T's stock is not attractive to capital appreciation-oriented investors is its low revenue growth potential. The company faces intense competition from both its established rivals and new entrants in the telecom market, which limits its pricing power and customer retention. As a result of this competitive dynamic, AT&T is expected to increase its revenue by only 1.1% this year.
Verdict
AT&T is a popular choice for investors who are looking for a steady income stream from its generous dividend payments, as well as an opportunity to generate extra income by selling covered call options. The stock's low valuation and high yield also provide some protection for option traders who are concerned about the downside risk. However, AT&T is not a compelling value play that can offer significant capital growth in the near future.
The future of the U.S. telecom industry is highly uncertain, as low-cost alternatives and emerging technologies are both poised to disrupt the market over the next 10 to 20 years. Therefore, AT&T needs to reduce its debt burden and invest in innovative technologies to stay ahead of the curve to meet the growing demand for data-driven services. Until that threshold is crossed, AT&T is unlikely to meet the criteria as a dyed-in-the-wool value stock.
All told, AT&T screens as an interesting income stock that fits well into a diversified fixed-income portfolio. Furthermore, it is not a value trap, as income is a form of value. Following this theme, a strategy of selling covered calls every two weeks, collecting the dividend, and saving 20% to 30% of the income from the option premiums and dividends as a cash reserve could be a good way to earn passive income from this telecom stock.
