Should You Buy Verizon?

Bob is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The telecommunications industry is a haven for income investors. The underlying stocks are renowned for providing ample free cash flow and returning a large portion of their cash flow through to investors via hefty dividend yields.

You would think that telecom stocks would be ideal for more risk-averse investors who value stability and income from their stock investments. However, telecom stocks have been volatile in recent weeks. In light of this, should investors dial up Verizon Communications (NYSE: VZ) for addition to their portfolios? Or are you better off avoiding the stock altogether?

A dark time for dividend stocks

On June 19 and 20, the Dow Jones Industrial Average dropped more than 500 points over the two-day period. Both Verizon and close rival AT&T (NYSE: T) are Dow components, and each stock got crushed during the market rout.

Because of rampant market pessimism directly related to the Federal Reserve tapering off its monthly bond purchases and fear of rising interest rates, the twin telecom stocks suffered mightily. As the theory goes, dividend stocks are less valuable in a rising interest rate environment. Since prices and yields move in opposite directions, stock prices would need to decline in order for yields to rise in conjunction with interest rates.

To emphasize, consider that since hitting their recent highs, Verizon and AT&T have dropped 9% and 12%, respectively, in just a few weeks.

Steady underlying financial results

Excluding recent events, both industry titans display the solid fundamentals that make owning their stocks so valuable for investors who shun volatility.

Verizon has outperformed its major rival in recent months. The company’s first-quarter consolidated earnings per share rose 15% year over year. In particular, the success of Verizon’s Wireless segment continues to impress: Verizon Wireless realized 8% year-over-year increases in both service revenues and retail service revenues, and achieved record operating and earnings before interest, taxes, depreciation, and amortization (EBITDA) margins.

2012 served to be a prosperous year for the company and its shareholders. Last year, Verizon booked more than $115 billion in total revenues. The company generated $31.5 billion in operating cash flow, representing 5.7% growth versus the prior year.

Verizon used much of this cash flow to invest in its business and provide shareholders with meaningful returns. The company invested $16.2 billion in its networks last year and paid more than $5 billion in dividends.

It’s not as if AT&T is performing poorly, though. For its part, the company posted 12% higher quarterly diluted earnings per share year over year, and nearly $4 billion in free cash flow.

However, AT&T isn’t growing revenue as fast as its major competitor. Since 2008, AT&T has grown revenue by less than 1% compounded annually.

AT&T does reward shareholders with its free cash flow generation, though. The company has increased its shareholder payout for 29 years in a row.

One domestic telecom worth avoiding, however, is CenturyLink (NYSE: CTL). In February, investors were given a rude awakening when they found their company had cut its dividend 25% amidst providing its fourth-quarter and full-year results.

The company has continued to provide uninspiring results in recent periods. In its most recent fiscal quarter, CenturyLink saw revenues drop 2% year over year.

Telecom stocks are bought primarily for their dividends. It’s true that CenturyLink will use the savings to pay down debt and invest in its business, which are good things, but investors shouldn’t stick with a telecom that cuts its dividend.

Causes for concern

Rising interest rates supposedly make dividend stocks less attractive. Indeed, the 10-Year Treasury Bond has sold off considerably in recent weeks, with its yield climbing all the way to 2.43%. Dividend stocks such as Verizon and AT&T have sold off in tandem with the uptick in rates.

I don’t consider dividend stocks to be truly less valuable, even if interest rates rise. The company’s dividend yield is still several hundred basis points better than Treasuries. Moreover, Verizon produces solid free cash flow and has actually raised its dividend regularly over the past several years.

That being said, investors should expect continued near-term volatility. The market has clearly not appreciated recent statements by the Federal Reserve, and if the market continues to drop significantly, Verizon and AT&T will likely not go unscathed.

That being said, if Verizon’s dividend yield exceeds 5% once again—which would occur at a price of $41 per share—I’d consider it to be a welcome buying opportunity.

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Robert Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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