AT&T: What If You Bought At Market Highs?

Jun.22.14 | About: AT&T Inc. (T)

Summary

Stocks are at all-time highs but most investors feel the urge to invest their money somewhere.

With the Fed's statement about interest rates, stocks look even more attractive.

What's likely to happen if an investor buys shares in AT&T right now?

Since we believe in "it's not a stock market, it's a market of stocks," we are always on the lookout for buying quality stocks for the long run no matter where the overall market is. This article was written a few days ago debating what would happen if investors bought Altria Group (NYSE:MO) with the market being at all-time highs.

That article generated a few interesting comments that prompted us to continue the series with other stocks that are trading near 52 week highs, if not all-time highs. The second part of this series is about AT&T (NYSE:T). Let us get into the details.

Current Situation:

  • Like many stocks, AT&T is also trading near its 52 week highs at $35.39.
  • As a result, the yield right now is much lower than its 5 year average of 5.63%.
  • How wise is it to buy the stock now?

Yield on Cost Extrapolation:

The table below shows the yield on cost for an investor buying AT&T at this high-level. The assumed dividend growth rate is just 3%, which matches the recent past but seems to be on the lower side considering the prospects that AT&T has with DirecTV (DTV) and wireless growth.

Let us run through the scenario again: buying at the top of the trading range and assuming an anemic dividend growth rate still nets you a yield on cost of 7% in 10 years. Certainly not a bad deal but can it get better? Sure.

Click to enlarge

(Source: Current price and dividend data from Yahoo Finance)

Capital Gains Extrapolation:

While AT&T is primarily a dividend play, there are also enough reasons to be optimistic about for capital gains going forward.

  • If the DirecTV deal does go through, AT&T is eventually going to save some money due to synergy. The much hated CEO believes the future is about content streaming and the deal is expected to cut around 20% of U-verse's content costs. He is perhaps right and has gotten himself a nice partner in DirecTV. When Berkshire Hathaway says "This is a terrific transaction for all involved: Enhanced choice for consumers, coupled with increased value for both AT&T and DirecTV shareholders" you better believe the deal is of value to all parties involved.
  • It is hard to remember after 7 years that AT&T was the first iPhone carrier in 2007. Now in 2014, AT&T is set to become the first (and so far exclusive) carrier for Amazon's (NASDAQ:AMZN) Fire phone as described here. It remains to be seen how much of a dent this phone will make in the already crowded space but it has to be a positive for AT&T. When two of the biggest names pick you to be their first official carrier, you are doing something right.
  • Without taking into account any new activities like DirecTV or the Fire phone, AT&T's earnings are expected to grow at 6%/yr for the next 5 years. If that holds true, we will be looking at an EPS of almost $3.50. Even if we assign an average market multiple of 15, the stock should be at $52. Put that with the juicy yield and yearly increases (although small), you get a nice package.

But what makes us so confident?:

You might ask what makes us so confident about AT&T increasing dividends further when the company is spending like there is no tomorrow?

  • AT&T has a three decade long dividend growth history. Sure, the recent dividend growth rates have been anemic but the DirecTV deal has sparked some hopes of much higher dividend increases due to improved cash flow.
  • As covered in the article linked above, even the current free cash flow is very healthy to cover dividends. The quarterly dividend commitment of $2.38 billion is well covered by the average quarterly free cash flow of almost $4 billion.
  • The company will very likely announce another dividend increase in November 2014 and even if the new dividend is just $1.88/share, the yield on cost would inch towards 5.40%. As a reminder, the 5 year average yield has been 5.63%.

Conclusion: Again, looking at the current price action is not a bad idea but just because a stock is at its 52 week high it must not fall out of your radar. While AT&T is trading at around $35, the value investor's bible Morningstar.com has a fair value of $34. In other words, the downside seems minimal given the healthy yield and capital appreciation potential.

What are your thoughts on this giant? Please leave your comments below.

Disclosure: The author is long T, MO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.