AT&T Makes A Good Addition To A Dividend-Focused Portfolio

Apr.10.12 | About: AT&T Inc. (T)

AT&T (T) is one of the two dominant U.S. wireless carriers, competing with the other telecom giant Verizon (VZ). Together these two companies service 60% of wireless customers. AT&T is also the main local phone company in many states, with 40 million phone lines, 16 million internet users, and 4 million television customers.

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AT&T stock currently trades at $30.94, with a 52-week range of $27.29-$31.97. The current dividend yield is 5.69%, which is exceptionally high. Here is the dividend history for the last 10 years.

Year Dividend Growth
2002 $1.066 4.02%
2003 $1.368 28.25%
2004 $1.25 -8.59%
2005 $1.29 3.20%
2006 $1.29 0%
2007 $1.42 10.08%
2008 $1.60 12.68%
2009 $1.64 2.50%
2010 $1.68 2.44%
2011 $1.72 2.38%
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The growth rate of dividends has been a bit erratic, but the last three years has seen more predictable growth. Let's look at the payout ratios. I will use percentage of the free cash flow instead of earnings to determine the payout ratio.

Year Free Cash Flow (Mil $) Float (Mil Shares) Payout Ratio
2002 $8,402 3,345 42.45%
2003 $8,298 3,322 54.75%
2004 $6,997 3,326 59.2%
2005 $7,088 3,370 61.33%
2006 $7,295 3,892 68.82%
2007 $16,355 6,170 53.57%
2008 $13,321 5,958 71.56%
2009 $17,110 5,924 56.78%
2010 $14,691 5,938 67.90%
2011 $14,538 5,950 70.39%
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The payout ratio has been high for the last two years, around 70%. The average analyst estimate for earnings growth for the next 5 years is 7.78%, and I would expect this ratio to decrease as earnings increase faster than dividends.

Valuation

I will use the Dividend Discount Model to put an estimated value on the company. This model assumes that the value of a company is purely the sum of all future dividends discounted back today. This is a reasonable valuation method if you are a dividend investor. The discount rate should be your required rate of return, and I will use a discount rate of 8%, which is roughly the long-term growth rate of the market as a whole. I will assume that the dividend will grow by 2% annually in perpetuity, which is close to the dividend growth rate over the last few years. Using these parameters I arrive at an estimated fair value of $29.24 for a share of AT&T.

Conclusion

AT&T looks to be fairly valued from a dividend point of view, trading very close to my estimated fair value. AT&T has an exceptionally high yield, and even with fairly slow future dividend growth it looks like AT&T is trading at a fair price compared to the value of those future dividends. It would be a good addition to a dividend focused portfolio.

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