AT&T is now pushing against some short-term resistance just north of $36 per share. Can it bust through and see the $40s anytime soon? Can the stock outperform the S&P? I will look at some important metrics for the company, followed by my recommendation.
Some Key Metrics
A history of margins, ROE, and ROA are key indicators to look at and compare with peers. The trends of those metrics can give valuable insight to general corporate health.
The margins for both major telecom companies are at recent highs. In fact, although the above graph spans five years, the margins are actually at ten-year highs for both AT&T and Verizon.
A look at ROE and ROA:
Note that Verizon's ROE figure is distorted by a highly leveraged balance sheet. Verizon sports a debt/equity ratio of 8.64, while AT&T has a debt/equity ratio of 0.88 (Source: finviz.com).
In all of the metrics I have looked at above, AT&T performs similarly to its main competitor. Also, the general health of the company is solid and is trending upwards.
At 5.1%, AT&T has one of the highest dividend yields of any mega-cap company and has a long history of increasing the dividend, even right through the Great Recession (shaded area):
The high yield is, of course, a major factor for any investor in the stock. Growth in the dividend is important as well. The CAGR of the dividend over the last five years was a mere 2.3%. In addition, the payout ratio (as of last quarter) was 65.7%, so dividends are unlikely to increase more than a few percent each year going forward.
Valuation of the Stock
The forward P/E of AT&T has fallen in the last two years:
AT&T again compares favorably with its main competitor, as it sports a forward P/E slightly under that of Verizon.
Looking back farther will give insight on what a "normal" forward P/E is for AT&T:
The current forward P/E of 13.79 looks reasonable - if slightly high - based on past history.
Another metric I like to look at is the net common payout yield. The net common payout yield is the dividend yield plus the net buyback yield. For example, if a company with a market cap of $100 million repurchases $10 million worth of stock in the last twelve months, issues no new stock, and has a dividend yield of 3%, then the net common payout yield would be 13%.
Here, AT&T scores outstanding marks. Since the start of 2014, it is returning about 17%-18% to shareholders, which is extremely high. A yield of 8% or more I consider to be excellent, and a yield of 10% or more is exceptional (and rare to keep up for long).
A closer look at buybacks is in order:
Since the start of 2012, AT&T has reduced its share count by over 10%. In my opinion, the buybacks have been a very good use of funds.
Finally, I will look at the technical trend:
We can see that the 20-day SMA just crossed the 50-day SMA and that short-term momentum is upwards as we head into the company's earnings report (on July 21).
AT&T looks about fairly valued to me at its current forward P/E of 13.79. According to Yahoo Finance, analysts expect the next five years' EPS growth to average 5.64%. So while the PEG ratio is quite high, the dividend props up the stock to a large degree.
Going forward, the company could very well command a higher P/E if all goes well with the upcoming DirecTV (NASDAQ:DTV) merger. DirecTV has grown EPS at a strong 30.6% average annual rate over the past five years.
DTV will represent approximately 19% (by market cap) of the combined companies, and could give AT&T a shot in the arm. Additionally, about 1/5th of DirecTV's revenues come from the DirecTV Latin America segment, and there could be some interesting opportunities there for the combined company.
Going back to my contention that the forward P/E of 13.79 is reasonable, and factoring EPS of $2.83 in 2016, I come to a target price of $39 for end of 2015. Adding in the expected dividend payout gives a total expected return of about 15% over the next 17 1/2 months. That's a return in line with what an investor should expect from the average S&P 500 stock.
P/E expansion from the DirectTV merger is something to consider for 2015 and would propel the stock above my target price.
Clearly, AT&T is most attractive to the dividend investor. However, one should keep in mind that dividend growth is likely to be no higher than earnings growth - at a maximum - going forward. I expect dividend growth of about 2%-4% annually for the foreseeable future.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.