These 2 Popular Dividend Stocks are about to Underperform
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Market participants have been clamoring over dividends and have thus far reaped the rewards. But ultimately it is earnings that drive stock performance and a popular source of dividends is set to underperform: Telecommunication Services. The two stalwarts in this industry, AT&T Inc. (NYSE: T) and Verizon Communications Inc. (NYSE: VZ), with market capitalizations above $100 billion and dividend yields above 5%, should be sold because underperformance is likely in the coming year.
The sell thesis on these two high-yielding dividend stocks incorporates two key points -- the stock market will be higher in the coming years and telecommunication fundamentals are deteriorating. In a rising market, these stocks will likely grind up, but produce a total return below that achieved by the S&P 500. In fact, that has already happened. Since the S&P 500 bottomed on Oct. 3, 2011, it has produced a total return of 24% versus just 10% for T and 8% for VZ. This underperformance should continue and investors would be well served to find better alternatives.
AT&T is the largest telecommunications company in the S&P 500 with revenues north of $120 billion. It is the second-largest U.S. wireless carrier and will remain so after the T-Mobile USA acquisition was dropped following a U.S. Department of Justice inquiry on anti-trust grounds. The company’s revenues are about evenly split between wireless and wireline operations.
Verizon Communications is the largest U.S. wireless carrier thanks to a controlling stake in Verizon Wireless. The wireless segment comprises roughly 65% of total revenues with wireline contributing 35%.
Weak industry
The telecommunications industry is clearly losing the battle against cable companies. Average revenue per user (ARPU) for telecommunication companies is essentially unchanged since 2005. Cable companies, on the other hand, have been able to generate increasing total ARPU thanks to annual mid-single digit increases in video ARPU. With ARPU flat for teleco’s, that leaves subscriptions as the other growth avenue. However, the wireless saturation rate in the U.S. is above 90% and wireless subscription growth is now under 5% annually and declining. Neither the pricing nor unit growth outlook is attractive.
Weak fundamentals
The numbers bear out the above argument and the situation is only getting worse. AT&T reported earnings-per-share of $2.15 in 2011 versus $2.39 in 2007. Verizon reported 2011 EPS of $2.20 versus $2.33 in 2007. That is going in the wrong direction.
The return on invested capital, a key operating performance metric, is just outright bad for both companies. AT&T hasn’t achieved a ROIC above 7% in ANY of the last six years. Verizon is relatively better, but not good on an absolute basis with ratios ranging between 7% and 9% in the last six years.
Dividends will ultimately track earnings growth and that trend has already started to reveal itself. The yield on AT&T is 5.8%, but the five-year growth rate is just 5%. A similar story is seen with Verizon -- 5.1% yield and 4% growth rate.
And lastly, the valuation on the two stocks is lofty. AT&T stock trades at 13x earnings and Verizon stock at 16x earnings. That compares to the 14x multiple on the S&P 500 despite substantially less growth opportunities and an increasingly competitive landscape.
Bottom line
Stay clear of telecommunication shares, including the two industry leaders, AT&T and Verizon. They will not keep pace with the market in the coming years, even on a total return basis. The industry headwinds are not alleviating, there are negative growth rates, and valuation has plenty of room to move lower. The stocks look unappealing against other U.S. equity names, but do look attractive relative to U.S. corporate bonds. So it does makes sense to use these two stocks as a substitute to bond holdings, but for the equity portion of one’s portfolio, investors should seek other alternatives.
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