Introduction
This article is the final article in this series on the major sectors of the S&P 500, and a follow-up of sorts from my last article on the S&P 500 Utilities Sector. Telecommunication Services is the smallest sector of the S&P 500 index with only 5 constituents. And similar to the Utilities Sector, but perhaps even more so, it is a rapidly-evolving industry.
Consequently, and also somewhat similar to the Utilities Sector, the 5 companies comprising this sector are typically associated with low-to-moderate growth and high dividend yield. However, in contrast to the Utilities Sector, but with the exception of the two mainstays, Verizon Communications (VZ) and AT&T (T), S&P 500 Telecom Services companies lack the stability and consistency of growth in earnings and dividends more commonly seen in the Utilities Sector.
As a result, I feel it’s imperative that prospective investors look past the high current dividend yields and more closely into the fundamentals underpinning each constituent. A high current yield is only truly valuable when it is sustainable and reliable. Those attributes will be a function of how well and profitably each individual company is capable of performing as businesses in the future.
The S&P 500: Telecom Services Sector
The Telecom Services Sector makes up just over 2% of the S&P 500 index, and as such, is one of the least important components. The following is a brief description of the types of companies in the Telecom Services Sector, courtesy of Reuters:
“The Telecommunications Services sector consists of companies engaged in fixed-line and wireless telecommunication networks for voice, data and high-density data.”
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F.A.S.T. Graphs Portfolio Review: S&P 500 Telecom Services
The following portfolio review lists the 5 constituents comprising the S&P 500 Telecom Services sector. The list is created in earnings yield (EPS YLD) order, from highest to lowest. The two highlighted constituents, AT&T and Verizon, will represent the primary focus of the remainder of this article.
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AT&T Vs. Verizon: Who Wins the Battle Between Growth, Yield And Value?
As previously stated, the two premiere companies in the S&P 500 Telecom Services Sector are AT&T and Verizon. From the perspective of the retired investor and/or the dividend growth investor, both of these companies are appealing for their high current dividend yields and recognized prominence in their industry. Therefore, they are both widely-held in portfolios of investors seeking current income from their portfolios.
However, since there are so few names to choose from in the S&P 500 Telecom Services Sector, I thought it would be interesting to evaluate which of the two might be a better investment based on expected future total return. Although there are many similarities between these two iconic telecom brands, from a fundamentals perspective there are interesting differences.
Although both companies appear currently fairly valued, AT&T offers a higher current yield, a moderately lower valuation, but a lower expectation for future earnings and dividend growth than Verizon. Consequently, we are presented with a classic battle between growth, yield and valuation. Therefore, I thought it would be fascinating to run the calculations in order to ascertain which might produce the higher intermediate-term total return. Will growth trump a higher yield and lower valuation? The results might surprise you, as they did me.
Live Fully Functioning Earnings and Price Correlated Graphs on AT&T and Verizon
As most of my regular readers know, I routinely illustrate my investing thesis on individual stocks by utilizing the fundamentals analyzer software tool, FAST Graphs, which I co-founded. When I include an earnings and price correlated graph on a company in an article, I have only been able to offer a picture of a fully functioning graph. And, for most of the examples in this article, I have done the same.
However, with these featured high-profile Telecom Services stocks AT&T and Verizon, I offer fully functioning, live and interactive F.A.S.T. Graphs. This will empower loyal readers who are non-subscribers to more comprehensively analyze the historical operating results of these leading Telecom Services companies, and the capability to run numerous performance calculations in order to better answer the question I posed in the title of the article.
The future return potential for this year and next can also be calculated by pointing to the last price dot on the graph until it turns red, and then point to either one of the forward triangles on the orange earnings justified valuation line and potential future performance calculations on each, to include dividends, will be generated.
The orange horizontal column at the top of the graph will allow you to evaluate both companies over multiple time frames since 1996. Just point and click on any of the numbers (for example 5Y), and the earnings and price correlated graph for that time frame will be instantly drawn and earnings growth rates and adjusted historical normal P/E ratios are revealed in the box to the right of the graph.
Note that all graphs are produced in calendar years and include the current year, plus one year of forecast. However, the data is presented based on fiscal year reporting, which in the cases of AT&T and Verizon are December.
The reader can also point to any price (the black line on the graphs) and a pop-up will appear with the date, price and P/E ratio at that time. You can also click on any price point (point A, a red dot will appear) and then click on any other price point on the graphs (point B) and performance calculations, to include dividends, will appear.
As it specifically relates to AT&T, I suggest the reader focuses on running the 11 year (11Y) and shorter time frames as this represents the periods of time since SBC Communications acquired the company and took on its iconic name and symbol.
The legends at the bottom of the graphs (orange rectangle) are also interactive. If you look closely, you will see the grayed out words “Dividend YLD.” If you click on those words, a dividend yield overlay will be added to the graphs. This provides an additional valuation measurement that can be analyzed. To be clear, a higher dividend yield will correspond to a lower price valuation and vice versa. You can also add and delete the various metrics found in the orange rectangle by simply clicking on them. For anyone interested in learning more on how to navigate the graph, follow this link.
AT&T Inc.
Short Business Description Courtesy S&P Capital IQ:
“AT&T Inc. provides telecommunications services in the United States and internationally. The company operates through two segments, Wireless and Wireline.
The Wireless segment offers data and voice services, including local, long-distance, and network access services, as well as roaming services to youth, family, professionals, small businesses, government, and business customers. This segment also sells various handsets, wirelessly enabled computers, and personal computer wireless data cards through its owned stores, agents, or third-party retail stores; and accessories, such as carrying cases, hands-free devices, batteries, battery chargers, and other items to consumers, as well as to agents and third-party distributors. As of December 31, 2014, it served approximately 120 million wireless subscribers.
The Wireline segment provides switched and dedicated transport, DSL Internet access, network integration, managed Web-hosting, packet, and enterprise networking services, as well as intrastate, interstate, and international wholesale networking capacity to other service providers. It also offers voice services consisting of local and long-distance services; and wholesale switched access services to other service providers, as well as sells customer premises equipment and other equipment comprising basic telephones and private digital switching systems. This segment served 9 million retail consumer access lines, 9 million retail business access lines, and 2 million wholesale access lines.
The company was formerly known as SBC Communications Inc. and changed its name to AT&T Inc. in November 2005. AT&T Inc. was founded in 1983 and is based in Dallas, Texas.”
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AT&T Guidance courtesy S&P Capital IQ:
In order to calculate future performance within a reasonable degree of accuracy, investors need guidance relating to future earnings growth. Moreover, consensus analyst estimates are often initiated based on corporate guidance. This should be kept in mind when the future potential performance of AT&T versus Verizon is presented towards the end of this article.
“For the year 2015, AT&T expects to continue consolidated revenue growth, EPS growth in the low single digit range, improving free cash flow and dividend coverage and capital expenditures to be in the $18 billion range.”
AT&T Risks and Opportunities According to MorningStar
Investment Thesis 03/02/2015
We aren’t fond of several capital-allocation decisions AT&T has made recently, including the acquisition of DirecTV, the foray into Mexico, and the substantial sum spent at the AWS-3 spectrum auction.
Bulls Say
AT&T has direct relationships with millions of residential and business customers. The firm’s network upgrade plans should enable it to offer these customers more and better services, driving revenue growth.
AT&T and Verizon Wireless stand head and shoulders above the rest of the U.S. wireless industry. The wireless business should generate strong profits and differentiate the firm from the cable companies.
The DirecTV acquisition will make AT&T a giant in the television industry, providing it with the clout needed to shape the future direction of this business.
Bears Say
A large portion of revenue and cash flow still comes from fixed-line local and long-distance phone services, but these businesses remain under attack from competitors and technological substitution.
AT&T’s heavy reliance on the iPhone is an issue. About half of its retail customers use the device. Weaning customers off large iPhone subsidies could prove difficult in the current competitive environment.
AT&T’s local network upgrade may leave the firm with too little capacity to offer the data speeds customers increasingly demand. The DirecTV deal provides yet another outmoded network.”
Verizon Communications Inc.
Short Business Description Courtesy S&P Capital IQ:
“Verizon Communications Inc., through its subsidiaries, provides communications, information, and entertainment products and services to consumers, businesses, and governmental agencies worldwide.
The company’s Wireless segment offers wireless voice and data services; messaging services; service that enables its customers to access the Internet on smartphones, basic phones, notebook computers, and tablets; customers and business-focused multimedia offerings; location-based services; global data services; LTE Internet, a high-speed Internet service; and network access and value added services to support telemetry-type applications. It also offers machine-to-machine services that support devices used in health monitoring, education, manufacturing, utilities, distribution, and consumer products markets, as well as offers smartphones and basic phones, tablets, and other Internet access devices. As of December 31, 2014, it had 108.2 million retail connections.
Its Wireline segment provides high-speed Internet, FiOS Internet, and FiOS Video services; voice services, such as local exchange, regional and long distance calling, and voice messaging services, as well as VOIP services; private Internet protocol and Ethernet access and optical services; and Internet protocol, infrastructure and cloud services, machine-to-machine services, security, and other communications services. It also offers voice and data services, such as conferencing and contact center solutions, and private line and data access networks, as well as customer premise equipment, installation, maintenance, and site services; and data, voice, local dial tone, and broadband services primarily to local, long distance, and other carriers.
The company was formerly known as Bell Atlantic Corporation and changed its name to Verizon Communications Inc. in June 2000. Verizon Communications Inc. was founded in 1983 and is based in New York, New York.”
The following comparison between AT&T and Verizon by segment courtesy of Dividend.com:
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“Verizon at a Glance (from their corporate website)
We are problem-solvers, engineers, technologists and innovators. Every day, we connect millions of people, companies and communities with our powerful technology. Not many companies get the chance to change the industry and the world through innovation. We do.
We Are Powerful Networks
Speed. Power. Innovation. Our investment in superior wireless, fiber optic and global IP networks puts Verizon at the center of powerful growth markets. Our networks enable us to deliver innovative services like cloud, video and telematics to enrich the lives of our customers around the globe.
Verizon is one of the largest communication technology companies in the world. We operate America’s largest 4G LTE wireless network and the nation’s premiere all-fiber broadband network.”
Verizon: Risks and Opportunities According to MorningStar
“Investment Thesis 03/02/2015
Verizon has focused relentlessly on network quality over the years, cementing its reputation with customers and its position as the premier U.S. carrier in terms of customer loyalty and profitability. This position has enabled the firm to weather increased competitive intensity well.
Bulls Say
Verizon Wireless is the clear leader in the industry, with 108 million retail customers and coverage of more than 95% of the U.S. population. The firm’s customers remain the most loyal in the business.
Among the traditional phone companies, Verizon has the best strategy for the long-term future of its fixed-line business. Its FiOS network enables unparalleled data speeds.
Acquiring 100% of Verizon Wireless should enable Verizon to better create packages of services aimed larger business customers with locations across the U.S.
Bears Say
Verizon Wireless is performing well, but the cost of maintaining network quality is high. Wireless capital spending topped $10 billion in 2014 (14% of sales).
Verizon Wireless will need all the spectrum it holds and more to meet data growth. Spending on spectrum, including the $10 billion spent in the AWS-3 auction, will hurt returns on capital.
Customers are increasingly replacing their traditional phone lines with wireless and data services or switching to competing carriers. Verizon’s ability to extract high margins through its phone network is declining.”
Verizon Guidance courtesy of S&P Capital IQ:
In order to calculate future performance within a reasonable degree of accuracy, investors need guidance relating to future earnings growth. Moreover, consensus analyst estimates are often initiated based on corporate guidance. This should be kept in mind when the future potential performance of AT&T versus Verizon is presented towards the end of this article.
“The company provided consolidated earnings guidance for the year 2015. For the year, the company expects consolidated revenue growth of at least 4%, sustained profitability with a consolidated adjusted EBITDA margin at a level consistent with full-year 2014 performance. The company expected strong free cash flow generation with consolidated capital spending of between USD 17.5 billion and USD 18.0 billion. The company expected an increase in total cash income taxes, with an expected effective tax rate for book purposes in the range of 34% to 36%.”
AT&T versus Verizon: Are the Dividends Safe?
The following FUN Graphs (Fundamental Underlying Numbers) compare the capital expenditures per share (capxps), cash flow per share (cflps), dividends per share (dvxps) and levered free cash flow per share (lfcflps) of AT&T and Verizon. These are primary metrics to evaluate when determining if the company’s dividend is safe or not.
Both AT&T and Verizon appear to be covering their dividend quite well based on cash flows. Moreover, both of these companies have similar histories and records pertaining to the other metrics presented.
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AT&T vs. Verizon: The Expected Total Return Winner Is?
The following FAST Graphs “forecasting calculators” are based on consensus earnings estimates from a similar number of analysts reporting on both companies and provides a calculation of the potential future total returns (capital appreciation plus dividend income) on both companies out to fiscal and calendar year-end 2017. Interestingly, the future total returns for both companies compute out to be virtually a dead heat or tie.
These calculations are based on the following reasonable assumptions. Both companies’ total return calculations assume that each will command a normal P/E ratio of 15 by year-end 2017. The earnings and dividend growth of each company is expected to track forecast earnings growth over that time period.
Based on those assumptions, the results calculate out as follows. Verizon holds an advantage over AT&T because it should generate a higher growth rate of dividends based on expectations for a higher earnings growth rate. In contrast, AT&T holds an advantage over Verizon because of its higher yield and lower current valuation which implies a potentially higher level of PE ratio expansion.
I found these results fascinating for several reasons. The powerful contribution and importance that a higher dividend yield contributed to the total return calculations was enlightening. I also found it quite interesting how a lower current valuation could overcome the advantages of faster earnings growth. Most interesting of all to me personally, was how these calculations revealed and supported the significance of the three primary drivers of total return – valuation, growth and yield.
Based on the assumptions above, the future potential return of AT&T with its higher dividend yield and lower current valuation calculates out to 11.53% per annum. The future potential return for Verizon with its higher growth rate, but lower dividend yield calculates out to 11.24% per annum. Although this gives a modest advantage to AT&T, I consider the numbers close enough to call it a tie.
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Supplement: A Graphic Review of the Rest of the S&P 500 Telecom Services Sector
Frontier Communications Corporation (FTR):
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CenturyLink, Inc. (CTL)
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Windstream Holdings, Inc. (WIN)
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Article Summary and Conclusions
The S&P 500 Telecom Services Sector represents a small portion of the overall index. As it relates to retired investors and dividend growth investors, I believe that AT&T and Verizon represent the best opportunities out of the five constituents in this sector.
However, I suggest that prospective investors carefully examine both of those companies in greater detail. I would further suggest that careful attention be paid to each respective company’s balance sheets, debt levels and overall quality.
In today’s low interest rate environment, both of the above companies offer attractive current dividend yields and the potential for low double-digit annual total returns over the intermediate-term future. However, prudent investors should not be blinded solely by high yield. Consequently, as always, I recommend a more comprehensive research and due diligence effort be conducted. Hopefully, the research provided in this article will assist in making that effort easier and more efficient.
Series Summary and Conclusions
This is the final article in this series on dissecting the 10 major sectors of the S&P 500. In Part 1 found here, I presented a valuation overview of the S&P 500. In Part 2, I reviewed the Energy Sector component of the index, and in Part 3, I reviewed the Information Technology Sector. In Parts 4A and 4B, I reviewed the Financial Sector, and in Part 5, the Healthcare Sector. In Part 6, I reviewed the Consumer Discretionary Sector. In Part 7, I reviewed the Industrials Sector of the S&P 500. In Part 8, I reviewed the Consumer Staples Sector. In Part 9, I reviewed the Materials Sector. In, Part 10A, I reviewed the Utilities Sector. And finally in this Part 10B, I reviewed the Telecommunication Services Sector.
My primary objective for presenting this series of articles was to provide readers a more comprehensive and detailed look under the hood of the S&P 500 index. There are many that favor and support index investing over constructing and managing their own self-directed portfolio. Although I do not consider myself a member of that camp, I do respect those investors that are more comfortable utilizing a strategy of investing into a broad index.
Nevertheless, I hope that this work has provided all readers a more comprehensive understanding of what an index like the S&P 500 really is. I am a fervent believer that knowledge is power, and in the context of that belief, I endeavored to provide a deeper and clearer look into the many variations and types of companies that comprise the broad S&P 500 index.
Disclosure: Long T,VZ at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.