Dividend yields and stock performance tend to have an inverse relationship. When stock prices go up, yields go down, and vice versa. An astute investor can effectively buy high quality income streams in beaten-down equity markets. However, the quality of the underlying stock determines the duration that income-stream will last. A high dividend yield means one of two things. One, a stock has been beat down due to macroeconomic conditions, and the income stream produced by its dividends are a true opportunity. Or, the stock has had experienced eroding margins and events which could lead to the company cutting yields in the near future. Telecom companies are evidence of each of these conditions. I will qualify the quality of five enticing dividend-paying stocks below.
AT&T (T): Many investors feel like buying shares of AT&T is a patriotic duty. Owning AT&T is like owning a piece of American history. Nostalgia aside, the current 5.9% dividend yield is a warning flag for this patriot. AT&T is currently paying out 87% of its income in dividends. This leaves relatively little cash for growth and acquisitions. AT&T's PEG ratio of 4.00 suggests the company is overvalued and will not produce share price appreciation in the coming years. The Debt/Equity ratio of 62.54 suggests that AT&T will need cash to pay off its behemoth $71.23 billion debt.
AT&T has raised or maintained its dividend for nearly 3 decades. The company also announced plans to raise its dividend to $.44 from $.43 per share in 2012. Investors looking to invest in AT&T should purchase it solely for the dividend and not expect much in share price appreciation. Dividends are safe for the short-term, but keep a close watch on quarterly earnings performance and the payout ratio. For a behemoth like AT&T, a payout ratio as high as 80% may be seen as safe.
Verizon (VZ): Verizon follows similar logic to AT&T. A payout ratio of 94% and debt to equity of 62.75, investors are seeing double-vision. Verizon shares have an advantage over AT&T in two key areas. The first is its strong levered cash flow of $14.66 billion. This leaves Verizon plenty of cushion to pay its dividend and also invest in future growth. The second is a recent history of EPS growth. Verizon's EPS grew from $.89 in 2010 to $2.50 TTM 2011. For now, let AT&T keep the 0.7% yield advantage and invest with Verizon for dividend security, future growth and potential share price appreciation. A 5.2% quality dividend is a huge win with Verizon shares.
Nokia (NOK): Buying Nokia right now is the definition of bottom-fishing. Nokia has been out-innovated and out-performed by its competitors, and the stock price decline of approximately 50% YoY is evidence of this. The current dividend yield of 9% is unsustainable, considering Nokia has reported negative earnings the past three quarters. Those with iron stomachs may be motivated by Nokia's new partnership with Microsoft (MSFT). As a principle, I stay away from buying companies with consistent negative EPS results. Give Nokia a couple quarters to prove that its new leadership and strategic alliances will provide share price appreciation and dividend safety. There are many higher-quality buying opportunities than Nokia in its current state.
Frontier Communications Company (FTR): If it's too good to be true, it probably is. A payout ratio of 500% is clearly unsustainable. Unless Frontier has a proprietary money tree, I'm selling. Institutional ownership has declined 16.55% over the past quarter. With declining earnings and a dividend that was cut in 2010 from $0.25 per share to $0.19 per share, look for the downward trend to continue. I'm trying to find a reason to buy FTR, and simply can't. The current dividend yield of nearly 15% is simply fool's gold.
Vodafone (VOD): A bright spot to end the article. Vodafone has a solid business model with diversified revenue streams and a global presence with over 370 million customers world-wide, including a 45% ownership stake in Verizon Wireless. Vodafone boasts a 15% profit margin and has a best-in-class payout ratio of 54%. The only blemish in Vodafone's financials is its negative $4.27 billion in levered cash flow. Vodafone generates over $18 billion in operating cash flow, suggesting that it has invested heavily in long term assets and future growth. While the levered cash position is concerning, it does not substantially affect the quality of the stock. Vodafone's dividend is safe and its business is well-positioned for continued success. Take this British powerhouse to the bank.