Lock in High Dividend Yields That Are Also Safe
Even after multiple rate hikes from the U.S. Federal Reserve, savings accounts are still paying next to nothing. That’s why over the last several years, more and more income investors have started considering high-yield stocks.
The problem is, though, most high-yield stocks today are not known for their dividend safety. If you are saving for retirement, you probably don’t want to put your money in a company that might cut its payout soon.
And even if you have a bit more risk tolerance, buying companies with questionable yields can still be a painstaking process. For one, you’d have to pay close attention to the company’s financials to make sure it has enough money to cover the next dividend payment.
Still, that doesn’t mean investors should ignore high-yield stocks altogether. If you are willing to do the research, you can still find high-yield companies that can give even the most risk-averse income investor a peace of mind. Verizon Communications Inc. (NYSE:VZ) and AT&T Inc. (NYSE:T) serve as great examples.
Verizon and AT&T need no introduction. Most Americans are familiar with them because there’s a good chance that we have paid money to these two telecommunications giants at some point. By the fourth quarter of 2017, Verizon was the largest wireless carrier in the U.S. by the number of subscriptions, with a market share of 35.5%. AT&T, on the other hand, was the second-largest wireless carrier in the country with a market share of 33.4%. (Source: “Wireless subscriptions market share by carrier in the U.S. from 1st quarter 2011 to 4th quarter 2017,” Statista, last accessed May 22, 2018.)
Generous Distributions
In today’s market, the most obvious reason to consider these two companies is their generous dividend policy. Verizon stock pays quarterly dividends of $0.59 per share, which comes out to an annual yield of 4.85%. AT&T stock, on the other hand, has a quarterly dividend rate of $0.50 per share, translating to an annual yield of 6.15%.
To put it in perspective, the average dividend yield of all S&P 500 companies stands at just 1.83% at the moment. (Source: “S&P 500 Dividend Yield,” Multpl.com, last accessed May 22, 2018.)
Usually, investors have to take on more risk in order to earn a higher return. But in the case of these two high-yield stocks, I believe investors can collect oversized dividends without losing any sleep at night. Let me explain.
A Tough Industry to Enter
Whenever you see a massively profitable business, one thing is certain: a ton of people want a piece of the action. Telecom is hugely profitable, just take a look at your latest cell phone, cable, and Internet bills and you’ll see what I mean.
The neat thing is, not everyone who wants to enter the business can find a way. Building the necessary infrastructure to support cable and wireless services is extremely expensive. Existing companies—such as Verizon and AT&T, took decades to build their infrastructure. It would take a new company a huge amount of capital—and also time—to construct the infrastructure to begin offering some sort of telecom service. And even if the new entrant manages to accomplish all that, it would still have to find a way to convince customers to switch from their current service providers. Turning a profit would be difficult, to say the least.
And that, my dear reader, is why economic professors often use the telecom industry to illustrate the concept of oligopoly. In an oligopolistic market, a small number of firms capture the bulk of the market share.
For instance, in the wireless service business in the U.S., the market is dominated by just four major players: Verizon, AT&T, T-Mobile US Inc (NASDAQ:TMUS), and Sprint Corp (NYSE:S). Together, these four companies enjoy a market share of well over 95%. (Source: Ibid.)
With extremely high barriers to entry, existing players in the industry have been enjoying abnormally high profits for quite some time.
Recurring Profits Translate to Steady Dividends
I should point out that Verizon and AT&T are substantially larger than T-Mobile and Sprint in terms of subscriber count. Besides, they also contain other segments to diversify their profit stream.
One of the most important reasons to consider these two high-yield stocks is the stability of their business model. In a recession, consumers may not be buying as many new cars as before, but cell phone bills will likely be one of the last payments they decide to skip. In other words, Verizon and AT&T should have no problem operating through thick and thin.
Indeed, if you take a look at their dividend history, you’d see that both companies managed to pay not just a steady dividend, but an increasing one.
AT&T has delivered annual dividend increases to its shareholders for 34 consecutive years. Therefore, it’s a “dividend aristocrat,” a company that has raised its dividends every year for a minimum of 25 consecutive years. (Source: “AT&T Inc. Historical Dividend Data,” AT&T Inc. last accessed May 22, 2018.)
Right now, you won’t find Verizon on the list of dividend aristocrats, but that’s because VZ stock only began trading in 2000 as a result of the merger between Bell Atlantic and GTE. If you take into account its Bell Atlantic history before the merger, you’d see that the company has paid steady or increasing dividends for more than three decades. (Source: “Dividend History,” Verizon Communications Inc., last accessed May 22, 2018.)
Is the Best Yet to Come?
Here’s the best part: despite offering investors a growing dividend stream, both companies managed to have conservative payout ratios.
In 2017, AT&T’s adjusted earnings increased 7.4% year-over-year to $3.05 per share. The company declared and paid total dividends of $1.96 per share for the year. That gives AT&T a payout ratio of 64.3%. (Source: “AT&T Reports Fourth-Quarter and Full-Year Results,” AT&T Inc., January 31, 2018.)
It’s a similar story at Verizon. The company generated adjusted earnings of $3.75 per share while declaring total dividends of $2.34 per share in 2017. That translated to a payout ratio of 62.3%. (Source: “Verizon closes 2017 with strong wireless customer growth and retention, well-positioned in new markets,” Verizon Communications Inc, January 23, 2018.)
Here at Income Investors, we prefer companies that pay out less than 75% of their profits due to the margin of safety. Both Verizon and AT&T’s numbers are well within our comfort zone.
If these two high-yield stocks can keep up the growth momentum in their business, they should have no problem continuing their dividend increase track records. Adding in the stable nature of their operations, Verizon and AT&T could be the long-term winners in an income portfolio.