Dividend Report Card: Verizon

In this series, we analyze financial metrics to begin answering the following questions about a company's dividend:

1. Over time, has this company steadily increased its payouts?
2. How sustainable is the dividend?
3. Does the company have room to further increase the dividend?

The Dividend Report Card wasn't designed as a buy or sell signal but rather as a tool to gauge the health of a company's dividend. For a full explanation of each category, click here for a tutorial.

Today's pupil is Verizon (NYSE: VZ), which posts a 5.4% yield.

Dividend history

Source: Verizon investor relations.

Verizon's dividend track record leaves a little something to be desired, especially when inflation (as measured by the CPI) was around 2.1% annualized over the same period.

Based on the low growth rate, Verizon scores a 2 of 5 in this category.

Sustainability

Source: Capital IQ, a division of Standard & Poor's, as of Feb. 24.

Verizon does have a fairly good balance sheet backed by hard assets and it can cover its interest payments a few times over. Indeed, Morningstar gives it an "A-" credit rating.

There's little question that Verizon can raise debt when needed -- though it's been rapidly paying down debt in the past year -- but in terms of maintaining the current dividend, the answer isn't quite as certain. Both the earnings and free cash flow to equity cover, for instance, has been weak in recent years.

Verizon may have the financial resources to maintain the current payout, but a major acquisition may really call into question the sustainability of the dividend.

Growth

Based on this data, it doesn't seem like Verizon has a lot of dividend growth potential.

For example, analysts are estimating $2.18 earnings per share in 2011, so even if Verizon maintains the expected full-year dividend rate of $1.95, it will still result in a high payout ratio of 89%. In other words, there's not a large "margin of safety" in case earnings fail to meet expectations.

Finally, with a payout ratio over 100%, the sustainable growth rate [return on equity x (1-payout ratio)] is actually negative. In fact, the past few years have seen low or negative sustainable growth rates.

Competitors
An "ungraded" section of the dividend report card is to see how a stock's current yield stacks up against that of direct competitors. If it's too high relative to competitors' yields, the board could be tempted to slow the growth rate, or vice versa, to bring it more in line with the industry average.

With its current yield at 5.4%, Verizon's dividend yield doesn't seem too high or too low relative to analyst earnings growth estimates of 4%.

Pencils down!
With all the numbers in, here's how Verizon's dividend scored:

Comparing Verizon's Dividend Report Card score to AT&T's score of "B" it's easy to see there are some key differences between the two U.S. telecom giants. Maybe Verizon's prospects will improve with the introduction of the iPhone to Verizon Wireless, but as of right now, the dividend opportunity isn't too exciting.

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