AT&T (NYSE:T) certainly isn't an exciting stock. The stock has slipped 2% since the beginning of the year and underperformed the S&P 500's paltry 2% gain. But after watching this dull stock over the past few months, I finally decided to buy some shares. Here are my top three reasons for doing so.
1. Rock-solid dividends
First and foremost, I bought AT&T for its 5.6% forward yield. That yield has fluctuated between 3% to 6% over the past decade, and the company has hiked its dividend annually over the past 30 years, making it a "dividend aristocrat". AT&T's dividend hikes aren't big, averaging about 2% over the past five years, but they're unlikely to stop anytime soon.
By comparison, Verizon (NYSE:VZ) pays a forward yield of 4.8%, and it's only boosted its dividend for eight consecutive years. Nonetheless, both stocks have much higher yields than the S&P 500's average of 2%. Over the past 12 months, AT&T paid out 69% of its free cash flow as dividends, compared to 95% at Verizon. But on an earnings per share basis, AT&T paid out 185% of its earnings as dividends, compared to 92% for Verizon.
This means that AT&T pays out more than it earns -- which seems troubling because its net income has been declining. Last quarter, AT&T's net income slipped 3%, and its earnings per share fell 17%, primarily due to its $49 billion acquisition of DirecTV. But now that the acquisition has closed, AT&T believes that its free cash flow, bottom line growth, and payout ratio will all stabilize.
2. Low valuations
The prospect of Fed rate hikes casts a shadow over high-yielding dividend stocks, since some income investors will switch to bonds once yields improve. But in my opinion, high-yielding stocks with high valuations will be more vulnerable when that happens. AT&T has a high yield, but its valuations aren't high.
AT&T initially looks pricey at 34 times earnings compared to the average P/E ratio of 22 for both domestic telecom companies and the S&P 500. But AT&T trades at just 12 times forward earnings, while Verizon and the S&P 500 have respective forward P/E ratios of 11 and 17. AT&T's price to FCF ratio of 12.5 also compares favorably to Verizon's ratio of 21. This means that AT&T is cheaper based on its free cash flow, which surged 57% annually to $5.5 billion last quarter.
That's because AT&T expects the DirecTV deal to become accretive to its free cash flow and earnings by next summer, then produce over $1.6 billion in cost synergies by the third year. As long as AT&T fulfills those promises and valuations stay low, it's less likely to be sold off in a Fed-induced panic.
3. Upside potential
While few investors think of AT&T as a growth stock, its numbers are rising. Last quarter, it added 2.5 million domestic wireless customers, 192,000 IP broadband customers, and 26,000 domestic DirecTV customers. It also added the most prepaid wireless customers in nearly eight years. Its churn rate remained low at 1.33%, indicating that fears about competition could be overblown. Revenues rose 19% annually to $39.1 billion, thanks to the DirecTV acquisition. AT&T also expects its full-year EPS to rise 7% to 9% this year, well above the consensus estimate of 5%.
Looking ahead, the DirecTV deal will allow AT&T to diversify into Latin America, where demand for pay TV services is climbing. While a strong dollar will hurt DirecTV in the near term, the tables could turn once the dollar cools off. AT&T also recently announced that it was expanding its high-speed fiber network to 23 new cities. This expansion should widen its IP broadband customer base. Lastly, its expansion into the Internet of Things, which includes wearables, connected cars, and smart homes, could tether more customers to its telecom ecosystem.
The bottom line
In my opinion, investors looking for a stable income-generating stock should consider buying AT&T. The stock certainly won't double from current prices, but it trades at a discount to the market, it pays a generous dividend, and the company is finally entering a new period of growth after years of stagnation.
Leo Sun owns shares of AT&T and Verizon Communications. The Motley Fool recommends Verizon Communications. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.