Much has been made of AT&T's (T) "unsustainable" dividend in the past year or so. Critics argue that T's payout ratio of roughly 150% is dangerous and cannot be continued. This would be correct, if T was paying its dividend out of earnings. However, it isn't. In fact, no company pays its dividend out of GAAP earnings, or net income. The reason is net income contains all sorts of non-cash items that are useful for informing investors and reducing tax bills but do little in terms of valuing the operating assets of a company. Companies do, however, pay their dividends out of cash flows. After all, T isn't transferring "earnings" to its shareholders; rather, it is transferring actual cash. I would argue, therefore, that T's headline "payout ratio" is nigh meaningless and should be ignored. The metric we should be paying attention to is T's payout as a ratio of operating cash flows. This is the actual cash the business generates and this is how T pays its shareholders.
First, let's take a look at the amount of dividends T has paid to its shareholders since 2001 in relation to its operating cash flows.
What we see is that regardless of the headline payout ratio that T may have had at various points, including now, operating cash flows have always dwarfed any dividend payouts. We see, for instance, last year's operating cash flows clock in at nearly $40 billion while dividends were just $10 billion. As you can see, the picture here is quite a bit rosier than the GAAP payout ratio number that gets quoted so often.
If we replace the denominator in the classic payout ratio formula with operating cash flows, we can see that T has more than double the cash it needs from operations to pay its dividend every year.
Instead of the 150%, panic-inducing GAAP payout ratio, we see that T typically uses less than 30% of its operating cash flows to pay its dividend. Further, this ratio has held very steady since 2007, indicating the dividend raises that have occurred have staying power.
Just in case you were wondering if T's substantial capital expenditures might cause the company to cut its dividend, we can see here that T amply covers those costs as well.
T's investing cash outlay was about $20 billion last year versus operating cash flows of $40 billion, for instance. While there have been some years where investing cash flows have dwarfed operating cash flows, such as 2004, those are anomalies and the idea is that those large expenditures will produce operating cash flows in subsequent years. Looking at the graph, we can conclude that this strategy is working.
The point is that the next time you hear someone sounding the alarm on AT&T's payout ratio being unsustainably high, remind them that the company doesn't pay dividends with earnings, it pays them with cash. And as we've seen here, T has more than enough cash to continue to pay its dividend, fund its substantial capital expenditures and even continue to increase its dividend. So fear not, yield seekers, T is a great place to pick up a nearly 5% yield.