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This Just In: Banker Bullish on AT&T. But Verizon? Not So Much.

By Rich Smith - Feb 4, 2016 at 12:10PM

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According to DA Davidson, the former Ma Bell is starting to look like quite a dish.

AT&T (T -0.38%) is a bargain. Verizon (VZ 0.43%) isn't -- at least, not according to ace analyst DA Davidson.

This morning, Davidson announced a pair of new ratings in the telecommunications space. AT&T is a buy, says the analyst, and likely to go to $41 in a year (the stock currently costs less than $37 a share). Archrival Verizon, on the other hand  which costs less than $51, is unlikely to climb much farther than $53 -- and so deserves only a neutral rating.

Again, this is all according to DA Davidson. But should investors even care what this analyst thinks? That's what we're here to find out.

Valuing the stocks
Priced at 15.5 times earnings, AT&T shares look at first glance to be more richly valued than Verizon, which costs just 11.5 times earnings. AT&T does, however, have a handful of advantages that suggest it could be a better value than Verizon.

For one thing, AT&T pays a 5.3% dividend, a full 0.8 percentage points more than what Verizon pays. For another, it's growing faster. According to data from S&P Capital IQ, analysts who follow the two stocks expect AT&T to post 5% annual earnings growth over the next five years, versus just 4% growth at Verizon.

Both stocks carry substantial debt loads -- $121 billion (net of cash) at AT&T, $105.4 billion (net of cash) at Verizon. AT&T's debt load is the bigger of the two, but AT&T also has a larger market cap, making that debt load easier to bear.

And yet, in at least one respect, it's Verizon that's the clear winner: Last year, Verizon generated positive free cash flow of $21.1 billion, while AT&T's cash profit was $15.9 billion. Both companies' cash profits are currently running about 20% ahead of their GAAP-calculated "net profits." But Verizon's the one making the most cash-money, hands down.

By my count, that makes two points in AT&T's favor (dividend and growth), versus two others (P/E and cash production) favoring Verizon. So how do we break this tie? Maybe by...

E-valuating the analyst
We've been monitoring DA Davidson's performance as an analyst for nearly a decade here at Motley Fool CAPS, and our data shows that, by and large, Davidson does usually know what it's talking about. Ranked in the top 15% of investors we track, Davidson gets about as many picks wrong as it gets right -- but when it does call a stock right, it outperforms the market greatly. On average over the past decade, Davidson's picks have beat the S&P 500's performance by nearly 10 percentage points per pick.

And here's the best part: When it comes to stocks in the telecommunication services sector, Davidson does even better. For example:

Company

 

DA Davidson Said:

CAPS Says:

DA Davidson's Picks Beat S&P By:

Cbeyond

Outperform

*

38 points

Level 3 Communications

Outperform

**

53 points

tw telecom

Outperform

**

157 points (picked twice)

Note that Level 3 Communications bought tw telecom in June 2014. They're now one and the same company.

What it all means for investors
Personally, when I look at AT&T and Verizon, I focus on which company is generating the most cash profit, and which company's stock costs less relative to the cash it's generating. In this regard, Verizon currently sells for an enterprise value 14.8 times its free cash flow. AT&T's enterprise value-to-free-cash-flow ratio is 21.8 -- nearly 50% more expensive than Verizon's.

For me, therefore, AT&T seems the clear winner on valuation. At the same time, though, it's worth pointing out that both these valuations look very high relative to the anemic single-digit growth rates that most analysts expect to see from AT&T and Verizon over the next five years.

The real kicker -- where DA Davidson and its 58% record of accuracy in telecom might prove right, and my simple weighing of the stocks' relative values might prove wrong -- lies in the growth rates. DA Davidson sees "significant opportunities" for AT&T to grow faster than expected as the company leverages its ownership of DIRECTV in the U.S., and its Mexican wireless operations, to grow faster than other analysts expect.

If DA Davidson is right about that, AT&T could outperform expectations -- and outperform Verizon, too.

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Stocks Mentioned

AT&T Inc. Stock Quote
AT&T Inc.
T
$21.09 (-0.38%) $0.08
Verizon Communications Inc. Stock Quote
Verizon Communications Inc.
VZ
$51.64 (0.43%) $0.22

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