The Attractiveness Of AT&T At $40 Rather Than $35

| About: AT&T Inc. (T)

Summary

Over the past year shares of AT&T have gone from $35 to $40.

Instantly this may be off-putting for a good deal of investors.

However, I find it prudent to think about the attractiveness of a potential investment in terms of the current value proposition being offered rather than the share price alone.

A year ago shares of AT&T (NYSE:T) were exchanging hands at a price of around $35. Today the number is closer to $40 per share. And naturally you'd prefer to partner with a business at a lower rather than higher price. However, what's not so obvious are two basic notions: the aspect of time and considering what makes an investment compelling. I'll show you what I mean using a couple of examples.

The first thing to consider is that a higher price could be justified as a result of increased expectations. As we look back in time it's easy to "cheery pick" examples, so I'll try to keep it as straightforward and unbiased as I can. I'm going to use information presented by Value Line, because it gives nice snapshots in time.

In June of 2015, shares of AT&T were trading around $35. The dividend payout stood at $0.47 on a quarterly basis and the trailing prior year adjusted earnings-per-share was $2.50. The analyst presenting the Value Line report presumed that AT&T could grow earnings by 5% per annum and grow the dividend by 2% annually over the intermediate-term.

If those assumptions held you would anticipate AT&T generating $3.20 or so in earnings-per-share and paying out a $2.08 dividend payment after five years. The average historical earnings multiple for the company has been around 14. Using this number equates to a future expected price of nearly $45. In addition, you'd anticipate collecting nearly $10 in dividend payments, good for a total value near $55. Expressed differently, your total annualized gain expectation based on a $35 starting price would be about 9.3% per annum.

In June of 2016 shares of AT&T were trading around $40. And instantly you might be disinterested in this now much higher share price. Yet it can be informative to work within the same framework.

That same analyst in 2016 supposed that the prospects for AT&T are now a bit better: using an earnings growth rate assumption of 6.5% and a dividend growth rate assumption of 4.5%. Moreover, the trailing numbers are now a bit higher as well - last year's adjusted earnings of $2.70 and a quarterly dividend payment of $0.48.

If you use these assumptions, you come to an anticipated future EPS number of about $3.70 after half a decade. Using the same ending earnings multiple of 14 leads to a presumed share price of nearly $52. In addition, you'd also expect to collect more in dividends - roughly $11 - as both the current payout amount and assumed growth rate is now higher. You total anticipated value would be about $63. As compared to a share price near $40, this equates to an expected annualized gain of about 9.4%.

That's a bit of a paradox. It suggests that on anticipated total return basis AT&T could actually look a bit more interesting today at $40 than it did last year at $35, at least in the eyes of the above assumptions. If the assumptions and factors remained the same, obviously you would prefer the lower price. Yet that's not what happened. Instead, you had an improved business - with greater earnings and a higher dividend payout - coupled with now higher growth assumptions as well.

I think this sort of notion is important to keep in mind as you go about the investing process. Price movement alone does not determine the merits of an investment, especially given the idea that profitable businesses tend to get more profitable over time (and thus the share price generally follows suit over the long-term as well).

It may seem like a simple example, and really it is, but I believe this is something that is regularly looked over. And naturally it doesn't just exist with AT&T. Take say Johnson & Johnson (NYSE:JNJ) which has a good chance of churning out more profits 5, 10 and 20 years from now. Not guaranteed obviously, but a high propensity just as has been the case for the past decade. The dividend payment has a good shot at increasing to boot. Consequently, it's very likely that the share price will eventually be higher as well.

So for illustration, let's imagine that the share price is reasonably higher than it is today in a decade. That portion alone doesn't mean that today it's automatically a better investment at a lower price. Nor does it indicate that if the share price were say $200+ that it would then be a bad investment. The results will be a factor of the relative valuation at the time and the resulting business performance to come.

It's all about the current value proposition in relation to your baseline expectations. What's even more interesting, in my view, is the idea that AT&T at $40 can be just as interesting of an investment at $40 as compared to a lower price. Just because you didn't find the perfect time to invest doesn't mean that all is lost. This is a concept that's tied up in investor psychology, but doesn't have as large of an impact as you might imagine if you have a long-term time horizon.

Some might see that shares of AT&T went from $35 to $40 in the last year and think, "well gee, I missed the boat, what's next?" And to be frank, this sort of thing is certainly off-putting - given the choice today you'd much prefer the lower starting price. Moreover, we could naturally see lower prices in the short-term as well. Yet I think it's equally important to be cognizant of the idea that just because you didn't get the best deal, this does not mean that reasonable offers are not coming your way. The concept is to anchor yourself to valuation - as a function of both current results and upcoming expectations - rather than the share price alone.

Disclosure: I am/we are long T, JNJ.

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.