The Best Telecom Stock

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

When it comes to telecom stocks, the usual battle is between Verizon (NYSE: VZ) and AT&T (NYSE: T), the No. 1 and No. 2 wireless carriers in the U.S. Both stocks have high dividend yields associated with the telecom industry, making them common holdings for dividend-focused investors. But there's an even better telecom stock that is often overlooked. Sporting both a higher dividend yield and a higher dividend growth rate than the Big Two, Vodaphone (NASDAQ: VOD) is the superior choice in the telecom sector.

Overview

Vodaphone is one of the world's largest telecom companies, serving 404 million customers in over 30 countries. In addition, the company owns a 45% stake in Verizon Wireless, with the remaining stake owned by Verizon itself. This stake occasionally provides Vodaphone with a dividend, such as the $8.5 billion payment in 2012. A map of Vodaphone's main markets is shown below.

<img src="/media/images/user_13886/vod-markets_large.png" />

Source: Vodaphone

The global scope of the company is a big positive, and it maintains healthy market shares in many different countries. 

The Dividend
Vodaphone, unlike many companies, pays two dividends per year (an interim dividend and a final dividend). In 2012 the total dividend, excluding a special dividend, was $1.45 per share. With a current market price of $25.32 per share, this puts the dividend yield at 5.73%. This yield is higher than that of both Verizon and AT&T, which pay a dividend yielding 4.68%, and 5.14% respectively. 

Dividend growth is equally important to the dividend yield. Below is a table of dividend payments for Vodaphone, Verizon, and AT&T over the last decade.

<table> <tbody> <tr> <td> </td> <td><strong>VOD</strong></td> <td><strong>VZ</strong></td> <td><strong>T</strong></td> </tr> <tr> <td><strong>2012</strong></td> <td>$1.45</td> <td>$2.03</td> <td>$1.76 </td> </tr> <tr> <td><strong>2011</strong></td> <td>$1.41 </td> <td>$1.975 </td> <td>$1.72 </td> </tr> <tr> <td><strong>2010</strong></td> <td>$1.27 </td> <td>$1.925 </td> <td>$1.68</td> </tr> <tr> <td><strong>2009</strong></td> <td>$1.20 </td> <td>$1.87 </td> <td>$1.64</td> </tr> <tr> <td><strong>2008</strong></td> <td>$1.49 </td> <td>$1.78 </td> <td>$1.60 </td> </tr> <tr> <td><strong>2007</strong></td> <td>$1.36 </td> <td>$1.67 </td> <td>$1.42</td> </tr> <tr> <td><strong>2006</strong></td> <td>$1.09 </td> <td>$1.62 </td> <td>$1.33</td> </tr> <tr> <td><strong>2005</strong></td> <td>$0.73 </td> <td>$1.62 </td> <td>$1.29 </td> </tr> <tr> <td><strong>2004</strong></td> <td>$0.37 </td> <td>$1.54</td> <td>$1.25</td> </tr> <tr> <td><strong>2003</strong></td> <td>$0.27 </td> <td>$1.54</td> <td>$1.1175 </td> </tr> </tbody> </table>

* Vodaphone, Verizon, and AT&T dividend data

Over the last 10 years, Vodaphone's dividend has grown at an annualized rate of 18.3%, while Verizon's dividend has grown at 2.8% and AT&T 's dividend has grown at 4.6%.

One thing to note is that Vodaphone was the only of the three companies to decrease their dividend during the financial crisis. This suggests that the dividend stability is superior at Verizon and AT&T.

In 2012, Vodaphone's dividend grew by 2.8%, while Verizon's dividend grew by 2.78%, and AT&T's dividend grew by 2.3%. It's reasonable to expect the dividend of the three companies to grow at similar rates going forward. Therefore, Vodaphone's higher yield makes the company's dividend the best choice. 

Payout Ratio
* Data from Morningstar, using 1 GBP = 1.63 USD

One important thing to check is whether the company can afford to pay the current dividend. I'll calculate the payout ratio, which I'll define as the total dividend paid divided by the free cash flow.

In fiscal 2012, Vodaphone paid a total of $11.32 billion in dividends compared to $7.99 billion in FCF. This value, however, includes a special dividend. Only counting the normal two dividend payments the payout ratio for 2012 was about 92%. This is fairly high, but the average payout ratio over the past 5 years is lower at 84%. For a company paying a near 6% yield this isn't outrageous, although it will put a limit on future dividend growth. I would expect dividend growth to be between 2%-3% annually in the long term.   

Valuation

I'll use the dividend discount model to value a share of Vodaphone. This method assumes that the value of a company is solely the value of all future dividends discounted back to today. This is a reasonable valuation method for investors focused mainly on dividends. I like to use a discount rate of 8%, roughly the long term growth rate of the market as a whole. I'll calculate two values, one assuming a 2% dividend growth rate and a second assuming a 3% dividend growth rate, and use these two values to define a fair value range. Using the above parameters I arrive at a fair value for a share of Vodaphone of $24.65 - $29.87.

The Bottom Line

Given that all three telecom companies discussed should see similar dividend growth rates in the future, Vodaphone's superior 5.73% dividend yield makes it the clear choice in the sector. With a current market price of $25.32, the stock sits just above the lower bound of my fair value range. This means that as long as Vodaphone can grow its dividend by at least 2% per year then the stock is a fair value today. If the company can grow the dividend at 3% per year then the current price represents a 15% discount to the fair value. The results are clear: Vodaphone is a great addition to any dividend-focused portfolio.  


TheBargainBin has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Vodafone Group Plc (ADR) and Vodafone Group Plc (ADR). 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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