Why It's Too Early To Buy AT&T Or Verizon On The Downgrades

Jan.15.13 | About: AT&T Inc. (T)

Verizon (NYSE:VZ) and AT&T (NYSE:T) have been very popular dividend stocks for the past couple of years, however, both stocks have been acting weak lately and it might be too early to try buying the dip for a couple of reasons.

First of all, both stocks have recently been downgraded, which could keep selling pressure on the shares and keep buyers at bay. Analysts at UBS (NYSE:UBS) recently downgraded Verizon to neutral from buy and set a $44 price target. The analysts seemed concerned about a lack of catalysts and the possibility of reduced profits. Analysts at Macquarie seem to have similar concerns about AT&T, as they recently downgraded that stock and set a $33 price target.

Both AT&T and Verizon benefited from the popularity of the iPhone, however, recent reports state that Apple (NASDAQ:AAPL) has cut orders for iPhone 5 parts due to weak demand. That could be a sign that growth is slowing for everyone in the telecom sector and unless a revolutionary new smartphone comes out, the lack of a robust upgrade cycle might limit profit growth for telecom carriers.

Another reason why it might be too early to buy Verizon or AT&T is simply valuation. Both stocks trade at about 15 times earnings estimates, which is similar with the market as the S&P 500 Index (NYSEARCA:SPY) trades for around 14 times earnings. However, telecom stocks traditionally trade at a discount to the overall market because these companies traditionally have below-average growth rates. It appears that the demand for dividend income has pushed both of these stocks to trade at historically high PE ratios, however, both of these companies have a fairly high payout ratio, which could limit dividend growth in the future.

Analysts expect AT&T to earn $2.54 per share in 2013, and it pays $1.80 per share in dividends, which provides a 5.3% yield. That means the company is paying out about 70% of its net income to shareholders and that does not leave a lot of room for future increases, especially if earnings growth is slowing. Analysts expect Verizon to earn $2.84 per share in 2013 and it pays $2.06 per share in dividends, which is a yield of about 4.8%. That means it is also paying out about 70% of its net income and this could limit dividend growth as well.

With signs of slower profit growth, a high dividend payout ratio, and a relatively high price-to-earnings ratio, it appears to be too early to buy these stocks. Verizon shares traded down to about $40 in November and AT&T shares went to around $32. It might make sense to wait for a pullback to those levels before considering these stocks again.

Here are some key points for AT&T:
Current share price: $38.23
The 52-week range is $27.41 to $38.28
Earnings estimates for fiscal year 2012: $2.39 per share
Earnings estimates for fiscal year 2013: $2.57 per share
Annual dividend: $1.76 per share, which yields about 4.7%

Here are some key points for Verizon:
Current share price: $42.80
The 52-week range is $36.80 to $48.77
Earnings estimates for fiscal year 2012: $2.42 per share
Earnings estimates for fiscal year 2013: $2.84 per share
Annual dividend: $2.06 per share, which yields about 4.8%

Data sourced from Yahoo Finance. No guarantees or representations are made.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.