It can sometimes be difficult to determine whether a stock is really a cheap buy or if it's a value trap. The difference comes down to how strong the business is, and usually reflects whether the stock is doing badly due to market or industry conditions, or if its struggles are a result of the company's own poor performance.
That's why just screening for stocks that trade at low multiples can be risky, since it could result in you buying stocks that aren't that great to own. Multiples change over time. If a business is in rough shape and its earnings worsen, that cheap-looking stock could end up looking expensive in the future.
Verizon Communications (NYSE: VZ) is a cheap-looking stock today. It's trading at 18 times earnings, and when you look at analyst expectations for next year, then its forward price-to-earnings multiple is less than 9. The low valuation in conjunction with the stock's poor performance in recent years may have investors wondering if this is really a good investment, or if it is just a value trap. Below, I'll try to answer that question.
Why is Verizon struggling?
Over the past five years, Verizon shareholders incurred losses totaling 31%. If you include the stock's dividend, then its total returns are a negative 10%, with the payout softening the blow a bit for investors.
But generally, investors would like to see at least a positive return on an investment, especially when looking at a five-year stretch.
A good place to start when evaluating a business is by looking at the company's top and bottom lines. Verizon is profitable, but struggled to grow revenue and operating income in recent years.
VZ operating income (annual); data by YCharts.
The telecom company generated minimal growth in five years, and its earnings have declined. In Verizon's defense, however, the economy hasn't been ideal due to the pandemic and then inflation. Consumers and businesses have been dealing with a lot of adverse conditions in recent years. I would argue that the modest numbers above don't look so troubling when you factor in those items.
Consumers have also been holding off on upgrading their phones due to budgetary concerns. That could change in the near future with new artificial intelligence (AI) powered phones becoming available this year.
Another catalyst could be Verizon's pending acquisition of Frontier, which, if it goes through, will expand its fiber network. The downside is that it would add debt -- and interest rates remain relatively high.
What could it take for Verizon to turn things around?
Verizon isn't a growth machine, and investors shouldn't expect it to be. The main reason to invest in Verizon is for the dividend and the potential the business possesses for it to grow its operations over the long haul, but this isn't a stock that you would otherwise expect to achieve double-digit growth any time soon.
While it provides a 6.6% yield, investors can also earn high returns outside of the equity markets (perhaps not as high as Verizon's payout, but at much less risk) if they are worried about the company's high debt load.
It has close to $130 billion in long-term debt, and over the past nine months, Verizon has incurred interest costs totaling $5 billion, which is close to one-quarter of the $21.3 billion in operating income it posted during that time.
If interest rates come down, or the company pays down its debt -- or a combination of both occurs -- investors could warm up to the idea of owning the telecom stock again.
Is Verizon stock a bargain buy?
Verizon's business isn't broken by any means, which is why I wouldn't classify it as a value trap. There are catalysts on the horizon that can both grow its business (phone upgrades, the Frontier deal) and shrink its costs (lower interest rates), which could lead to a rally in the near future.
Waiting until those catalysts arrive could result in missing out on a stock that looks like a bargain right now, especially when you consider its high yield.
There's some risk with Verizon, but with rates potentially coming down further and the company still having solid interest coverage, I wouldn't be too worried about it. This is an underrated stock that investors may want to buy sooner rather than later.
Don’t miss this second chance at a potentially lucrative opportunity
Ever feel like you missed the boat in buying the most successful stocks? Then you’ll want to hear this.
On rare occasions, our expert team of analysts issues a “Double Down” stock recommendation for companies that they think are about to pop. If you’re worried you’ve already missed your chance to invest, now is the best time to buy before it’s too late. And the numbers speak for themselves:
- Amazon: if you invested $1,000 when we doubled down in 2010, you’d have $21,706!*
- Apple: if you invested $1,000 when we doubled down in 2008, you’d have $43,529!*
- Netflix: if you invested $1,000 when we doubled down in 2004, you’d have $406,486!*
Right now, we’re issuing “Double Down” alerts for three incredible companies, and there may not be another chance like this anytime soon.
*Stock Advisor returns as of October 28, 2024
David Jagielski has no position in any of the stocks mentioned. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.
