For most of the past decade, Verizon Communications(NYSE: VZ) has given its shareholders little to cheer about. The stock has woefully underperformed compared to the broader stock market. But over the past 12 months, that has changed: Verizon has beaten the market, with a total return of 45% to the S&P 500's 34%.
Verizon is getting a twofold benefit from the prospect of falling interest rates. Because it borrows often and is carrying a lot of debt on its books, lower rates will help cut its interest expenses. Additionally, as the rates offered by savings accounts and low-risk interest-bearing assets fall, investors seeking income will naturally gravitate to high-yield dividend stocks like Verizon.
Of course, the question is whether Verizon is a buy right now. Was Verizon's 2024 rebound from its decade low the start of something great, or just a temporary blip?
Verizon has struggled to grow earnings.
Telecom is a wide-moat industry, meaning it's hard for new competitors to enter the space. A few power players dominate U.S. telecom -- Verizon, AT&T, and T-Mobile US, which merged with Sprint in 2020. They each spend billions of dollars annually to build and maintain the infrastructure of their wireless networks.
Usually, companies in wide-moat industries have a degree of pricing power that helps drive their growth and can make them excellent investments. However, Verizon, America's leading wireless carrier with roughly 37% of the market, has struggled to grow earnings, for three primary reasons.
First, it has less pricing power than you might guess. All three major U.S. carriers offer nationwide coverage, so consumers often switch to whichever carrier is cheapest. Second, the market is saturated. Most Americans have smartphones today, and many also own other wireless devices like smartwatches. There isn't much organic growth left to pursue. Finally, the wireless business requires billions of dollars in infrastructure investments annually.
Verizon's non-GAAP (adjusted for non-recurring charges) earnings per share were $3.35 in 2014 and $4.71 in 2023, a 40% total increase over a decade. During that time, America's money supply increased roughly 88%. In other words, Verizon's earnings have seemingly grown more from inflation than anything else. Management is guiding for just $4.50 to $4.70 per share in adjusted earnings this year, signaling that earnings may decline. Analysts anticipate earnings only growing by 2.4% annually over the next three to five years.
Verizon's positive qualities
The lack of meaningful growth helps explain why the stock has produced poor investment returns for years. However, it's not all bad. Verizon's generous dividend yields 6.2% at the current share price. That's far more than the S&P 500's current 1.3% yield, and well better than the interest rates one could earn in high-yield savings accounts.
That makes Verizon more attractive for those looking to generate investment income.
Most importantly, the payout looks safe by most measures. Verizon can cover its dividend at current levels with its free cash flow alone and still have about 20% left over. The dividend is just 59% of Verizon's estimated 2024 net income. Verizon's profits are pretty steady, which should translate to peace of mind for those who depend on the dividend. Plus, Verizon has increased its payout annually for 20 consecutive years.
You still don't want to suffer heavy losses on your principal, even if dividends are your primary goal. That's part of what makes Verizon so appealing. It's a stable stock, with a beta of just 0.4. That means the stock is far less volatile than the broader market. So, Verizon generally won't go up as much when the market is doing well, but it probably won't plunge when the market crashes.
Is Verizon's price right?
The caveat with Verizon is that you shouldn't overpay for the stock because its earnings growth has been so poor, and its outlook doesn't look promising, either. As a reminder, analysts estimate Verizon will grow its earnings by an average of 2.4% annually over the next three to five years. That might not even keep pace with inflation. And since the stock has soared this year, its valuation is far different now than it was months ago. Verizon trades at just over 9 times its estimated 2024 earnings, compared to just 6 times earnings a year ago.
Earnings growth alone doesn't justify Verizon's valuation. The stock's price/earnings-to-growth (PEG) ratio is 3.9, and I generally don't buy stocks with PEG ratios that are stretched beyond the 2.0 to 2.5 range. However, the economy seems to be entering a period of falling interest rates, which could entice the market to award higher valuations to high-yield stocks like Verizon.
Verizon's current valuation creates a risk of muted total investment returns, but it may deter those more interested in the cash from the dividend. Verizon remains a solid option for income-seeking investors, but everyone else would likely be better off looking elsewhere for better opportunities.
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Justin Pope has no position in any of the stocks mentioned. The Motley Fool recommends T-Mobile US and Verizon Communications. The Motley Fool has a disclosure policy.
