Most of the long-term wealth in the stock market gets made by searching for one of two things. Either the accumulation of assets selling at a discount, or the purchase of securities trading at fair prices that have unusually have earnings per share growth rates. For long periods of time, AT&T stock has tended to fall in the category of undervalued because the investor community thinks it is too big to deliver any subsequent growth. But when the dividend of AT&T goes below 5%, history has shown us that the subsequent returns are usually below expectations and confirm the conclusion that the stock shouldn’t be bought when it is overvalued because it can’t just “grow out of it” like you could by overpaying for an investment in something like Visa or Nike.
What Are The Risks With ATT Stock?
You have got to get the price right. This part is non-negotiable. I’m looking at the T annual report from last year right now and I am looking at the annual revenue total of $164 billion. My hometown of St. Louis only generated $149 billion in economic activity last year. It is not hyperbole to point out that when you buy shares of ATT stock, you are becoming an owner of a Top 25 USA city.
That is a fantastic fact if you care about dividend stability. AT&T generates billions and billions in cash flows, has nearly unmatched access to bank borrowing, and has the resources to acquire Fortune 500 businesses outright such as DirecTV and potentially Time Warner.
When you are dealing with a business of such extreme size, you are making a trade-off in favor of stability and against growth. Even if everything goes right, you are going to get low to mid single digit earnings growth from this firm. My assumption is that those revenues of $164 billion wouldn’t double into the $300 billion until sometime in the 2030s.
That is usually fine because the high starting dividend yield from AT&T stock made it a successful investment. Look at its offering points since the recession: AT&T had a 6.4% dividend yield in 2009, 6.3% in 2010, 5.8% in 2011, 5.2% in 2012, 5.1% in 2013, 5.3% in 2014, and 5.6% in 2015.
As long as you lock in a yield over 5%, you should be fine. You get to collect your 5% in cash and experience low single digit earnings growth. But as you move below that 5% AT&T dividend yield point, you begin to sacrifice something on the total return side in pursuit of those dividends now.
As the price of AT&T stock moves into the $40s, I think it starts to lose a spot on the “buy now” list. If its core wireless services grow at the same rate, and the DirecTV acquisition plugs in the earnings hole created by declining wireline services, you ought to see earnings end up around $3.80 in 2021 (compared to AT&T’s current earnings of $2.85).
The company is usually fairly valued when it is trading in a range from 13x earnings to 15x earnings. At the top of the end of the range, we are looking at a stock price of $57 five years from now. With the current price at $41, it is up to you to decide whether that is enough capital appreciation to meet your needs. Personally, I don’t think this is the right season for buying AT&T stock. Wait for higher interest rates, or a price collapse following news that T has to pay a large breakup fee after an acquisition doesn’t go through (such as the $500 million it would pay Time Warner if regulators block it), and see if you can get your hands on T stock with a 5.5% to 6% dividend yield range.
The second risk with owning T shares is that the debt load is enormous. It costs a lot of money to make the necessary capital expenditures to provide wireline services in California, Illinois, Texas, Missouri, Ohio, Michigan, Wisconsin, Indiana, Connecticut, Nevada, Oklahoma, Kansas, and Arkansas. It costs a lot of money for AT&T to put together a wireless network. And the telecom giant carries $125 billion in debt and also has pension obligations of $55 billion with only $42 billion currently funded.
This is sustainable because the cash flows supporting AT&T stock is enormous. There is $40 billion coming through the corporate coffers each year, and about $17 billion of that flows to shareholders as net profits.
Since the cash flows are so enormous and stable, the extremely high debt burden does not pose a bankruptcy risk. But it does pose a risk to earnings growth. It would be unusually difficult for AT&T to deliver earnings growth over 5% even if it had no debt, but the existence of a $100+ billion debt burden cements the fact that AT&T shareholders ought to expect high single digit earnings growth.
How Many Shares Have AT&T Investors Picked Up Through Dividend Reinvestment?
Since 2008, the cumulative dividend payouts declared by AT&T has been $15.84. That is assuming that you don’t reinvest anything and that your share count remains stagnant. Because the dividend has been above 5% for most of this time period, the share has been able to rise at a nice little clip if you had been participating in some type of dividend reinvestment program to pick up new shares.
You would have collected $21.83 that got reinvested at an average price of $33.74 if delayed gratification and let your share count accumulate. In a time span of only eight years, each share of ATT stock would have created 0.64 new ones. If you had 100 shares of T back then, you’d have 164 shares now. Approximately 44 shares of them would have been created by the per share payout declared by the AT&T Board of Directors, and the other 20 would have been created because you had a higher total share count each quarter that would give you a greater claim on the amount that AT&T owed you.
To reinforce my point about needing to get the price right, consider this. There was a point in 2008 in which AT&T traded at $41.90. It’s at $41.30 right now. The only thing you’d have to show for your investment is the dividend—not even that, you’d have to make a sixty cent downward adjustment between the price of stock then and its price now.
Considering the price decline, your total returns have been satisfactory all things considered. If you paid $4,190 for 100 shares in 2008, your 164 shares of AT&T stock would be worth $6,773. If you held your shares in a retirement account, you would have compounded at a rate of 6.2% annually even though the price of the stock declined a bit over the holding period.
Lessons Learned From AT&T’s Share Price History
Don’t chase the dividend. You can never move past the fact that price matters. A lot. The experience of shareholders varies dramatically depending upon the entry point. Locked in AT&T shares in 2011 when the stock was yielding almost 6%? You’d have 13% annual return while collecting a cash dividend payout that is roughly triple of the payout from the S&P 500.
What if you bought shares of T ten years ago when the price was in the 15x earnings range and the dividend yield was below 5%? You’d only have earned 5.8% returns through the same day.
Whether you bought in 2007 or 2011, your ownership stake represents the profits generated from the exact same mobile telephone, landline, and broadband subscription. Yet the nature of the claim is radically different. If you waited for your price, you’d be earning double digit returns while collecting a large cash payout. If you didn’t wait for your price, and you were just in permanent buy mode ten years ago, the only thing you got was the dividend—no capital appreciation came your way.
People say it’s especially bad for dividend stocks when they get overvalued. I understand what they mean, but there is a more precise way to state the message. Slow growth companies that pay out most of their earnings as dividends pose a particularly high risk when they trade at high prices because you don’t have the prospect of unexpectedly high growth to bail you out from the excesses of your impulse. AT&T is so large that it can’t grow revenues per share at a rate more than 5%. You’re buying a cash cow with moderate growth, which is why its total returns are superior to most fixed income investments over time.
But now is not the time to chase after the AT&T stock dividend. At a minimum, you need to wait until it yields 5.5%. If you want to be in the realm of intelligent income investing behavior, you need to wait for a yield of at least 6%. I say this not in the spirit of someone who just points out the obvious that buying an asset at a lower price will lead to higher total returns than buying at a higher price. Instead, I offer this in the spirit of history. AT&T tends to only offer 4-6% returns when it gets valued like this. This stock shouldn’t be a candidate for investment until it trades below 13x earnings because that is the point at which you receive high current income without sacrificing total returns in search of dividends.
Originally posted 2017-01-10 17:33:47.