AT&T Remains Highly Recommended Despite Criticism

| About: AT&T Inc. (T)

Summary

AT&T's shares have exhibited stellar relative strength year-to-date, gaining ground at tough times and holding it otherwise.

Critics argue the stock is expensive, but I believe their arguments are mostly based on faulty premises.

T continues to produce reliable cash flows at a difficult time for most companies because it is a utility.

I view its competitive position viable.

Investors will continue to seek its superior yield and reliable earnings, and so it should continue to provide relative outperformance in terms of total return versus the market.

AT&T's (NYSE: T) shares have enjoyed a stellar year, despite a barrage of criticism all year long. When markets are turned upside down, T garners more capital support as expected, but when stocks have seemed to be gaining strength broadly, it has still held its ground. That is because the stock offers reliable cash flows at a time of uncertainty for the broader economy and market. Criticisms about its valuation are based on faulty premises of market environmental alteration or on a faster rise of other yield producing investment options than is realistic. Indeed, the death of AT&T and other income generating utility stocks has been greatly exaggerated. The outlook remains favorable for AT&T, as I believe it will continue to defy all criticism in 2016.

1-Year Chart of T at Seeking Alpha

The 1-year chart here for AT&T's shares shows superior relative strength. T shares have produced a total return of 25% year-to-date, including capital appreciation and dividends (today yielding 4.6%). That compares to about a -1.1% total return for the SPDR S&P 500 (NYSE: SPY).

First and foremost, AT&T, Verizon (NYSE: VZ), and other dividend paying utilities have served as safe harbor for capital in a year plagued by volatility. Stocks came under pressure right from the get-go of 2016, thanks to China's currency actions and the global market reaction to them. Then, as major central banks in Europe and Japan went to negative interest rate policies, investors began speculating that the U.S. might follow, especially given the Federal Reserve Bank asked lenders to stress test for negative short-term interest rates. Since then the market recovered before facing its latest challenge, the unfavorable result of the U.K. referendum.

During the tough times, yields for securities that risk averse investors target tend to decrease as capital flocks to them, including U.S. treasuries and other low-risk relatives. Income available via bank savings accounts and certificates of deposit hardly satisfy these days. So investors must seek out other options for relatively safe stores of cash that can generate better income. AT&T is one of those options.

AT&T is a utility providing what is deemed by society to be a necessity. Its cutting edge telecommunications services are a staple in every home and every pocket. As a result, its cash flows are relatively dependable. Dependable cash flows are important in today's market environment featuring falling EPS and EPS estimates, and given the questions about the economy and the possible rise of the cost of capital for cash needy firms.

For as long as AT&T can sustain market share against others like it, investors can have confidence in its cash flows. Its brand is established, though the competition is fierce and expanding beyond Verizon in some areas of its operations (read Netflix (NASDAQ: NFLX), Amazon.com (NASDAQ: AMZN), Apple (NASDAQ: AAPL), etc.). However, today, given its push in the provision of satellite television via the compelling DirecTV and its smart market targeting across wireless, I believe it can compete effectively. It certainly seems to draw on price while also presenting differentiated services that draw customers by their appeal.

Yet, the stock continues to find criticism. Pundits warn of its valuation, and their voices grow louder when the broader market strengthens. That is because if the investment environment is healthier, as implied by a strengthening market, then capital should find riskier ideas presenting greater capital appreciation upside. But that is not the case today, and I don't expect it to be the case for the next year or two. That is because as the Fed raises interest rates gradually (that's important), the cost of capital will slowly but decidedly be increasing, which is a tougher cost to bear for riskier stocks.

Some popular pundits argue that higher interest rates make AT&T less attractive because investors will have other options for yield. Wrong. If rates were going to rise quickly, that argument would apply, but at the pace at which our Fed is acting, it does not. And long-term interest rates are going to take even longer to get there, given the Fed intends to keep those down for some time longer (see future reports for more on this).

But even now, as investors seek refuge, I still hear those same voices issuing cautious statements about the richly valued telecommunications stocks. Yes, T's P/E ratio is rich on historical comparison and when compared to growth expectations for the company, but sometimes a stock is cheap or expensive for good reason. A better comparison would be of its valuation to relative periods, rather than the general mean valuation. Sometimes the reason a rich valuation can be expected to continue, and calls for the stock to continue to perform relatively well. "Relatively" well means against other stocks; I'm not referring to the stocks of companies it competes against but stocks generally. These are high times for AT&T and friends, and given my expectations for an ongoing environment of uncertainty, its valuation should be seen as appropriate. I cover AT&T closely now (see also this report) and invite relative investors to follow my business column here at Seeking Alpha for regular reports on the stock.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.