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First of all, I confess that Verizon is a well run company, generates solid cash flow and has a great wireless business. But the numbers suggest that Verizon (VZ) has gotten a fair bit ahead of itself.

First of all, Verizon is currently trading at $44.75, and is expected to do $2.50 in EPS this year. That is a 2012 multiple of 18x, pretty much it's all time highs. Today the S&P is trading at 1336, or roughly 13x its estimated $104 in EPS. The market is clearly paying up for its stable dividend and nice yield.

However, history shows that Verizon has not really grown its earnings. In fact, while its dividend has been steadily increasing, this is mostly due to the company adopting ever higher levels of payout ratios.

So, here are the EPS numbers going back to 2004, which fortunately are reported excluding the Minority Interest in Vodafone's stake in Verizon Wireless.

Adjusted EPS

2004

$2.51

2005

$2.56

2006

$2.54

2007

$2.39

2008

$2.54

2009

$2.26

2010

$2.20

2011

$2.15

2012

$2.50

The numbers are non-GAAP adjusted EPS figures as reported by Verizon's 10Ks to exclude non-recurring and non-cash items. Stability seems to be the best adjective to describe Verizon. In fact if the company hits its $2.50 earnings estimate for 2012, that will mean its EPS, since 2004, is pretty much flat.

Lets add the Dividend numbers to this table.

Adjusted EPS

DividendsPayout Ratio

2004

$2.51

$1.54

61.35%

2005

$2.56

$1.60

62.50%

2006

$2.54

$1.62

63.78%

2007

$2.39

$1.65

68.83%

2008

$2.54

$1.75

68.90%

2009

$2.26

$1.86

82.08%

2010

$2.20

$1.91

86.93%

2011

$2.15

$1.96

91.28%

2012

$2.50

$2.01

80.50%

Dividends have grown by 30% cumulatively since 2004, but merely by increasing its payout ratio on its earnings, from 61% to 81%. That is a big move. In fact last year the payout ratio was 91%! Without real growth in earnings, I question how much longer this can last. This chart below illustrates it well.

Verizon's annual reports can be found here.

P/E Relative to S&P

I also wanted to determine if Verizon has historically traded above the market or the S&P's price-earnings multiple. So, going back to 2005, here are the high's and low's on Verizon stock:

Stock Price Low

Stock Price High

2005

$29.52

$39.41

2006

$30.90

$38.84

2007

$36.32

$45.60

2008

$25.08

$42.60

2009

$27.28

$34.64

2010

$26.69

$35.93

2011

$34.30

$39.00

2012

$36.80

$45.00

Its traded at a consistent range between $30 and the low 40's, with one breakout to $45 during the heyday of 2007.

Using the EPS numbers, it was simple to determine the historical P/E ratios on VZ over time:

Low P/E

High P/E

2005

11.53

15.39

2006

12.17

15.29

2007

15.20

19.08

2008

9.87

16.77

2009

12.07

15.33

2010

12.13

16.33

2011

15.95

18.14

2012

14.72

18.00

The 2012 numbers are year to date. In and of themselves, the stock, now trading at its high multiple today of 18x earnings so far into 2012, is only 1 multiple shy of the all time stock highs that it traded in 2007 of 19x.

I think the upside to buying VZ today is that it can get to 19x, which is an aggressive upside target, and only provides a pre-dividends return of 6% on your investment. There isn't really a scenario where I think VZ is worth 20x earnings. That seems too aggressive given its historical performance and its growth trajectory.

More interesting is the level that VZ has traded at compared to the S&P500. So, while Verizon has traded pretty close to the S&P500 over time, now it has spiked to a pretty large premium.

Avg P/E

S&P 500 P/E

2005

15.39

17.2

2006

15.29

16.8

2007

19.08

16.5

2008

16.77

10.9

2009

15.33

18.6

2010

16.33

15.5

2011

18.14

13.7

2012

18.00

12.7

Average

16.79

15.24

This chart below is the P/E multiple of Verizon, LESS the P/E of the S&P 500.

This one is a little more eye-opening. I'd suggest that when Verizon trades at or below the S&P's multiple, it's a buy. Clearly in 2009, Verizon was heavily penalized, and in 2005 and 2006 the market didn't much care for the company either. Today, however, the stock trades 5 multiple points better than the S&P!

Likely too much attention on stable dividend paying stocks has the market ignoring that fact that these names are getting ahead of themselves.

Since 2005, the average free cash flow yield (inverse of the P/E) has been 6.82% for Verizon. Applying a 6.82% FCF yield to VZ stock today yields a valuation of $36.65 per share. That is downside of 18% if the market decided it should trade back to its historical average.

Now, in every year except 2011, going back to 2005 that is, Verizon has traded at a low P/E somewhere between 11 and 12x. If Verizon fell to a market multiple of 13x, then the stock could fall as low as $32.50. Clearly that marks a buy price.

Conclusion

I am not suggesting that the business has any real issues here. It's actually doing fine. EBITDA was up 7% last quarter on a year over year basis. My argument is that when things are great, and a stock is trading at all time high multiples, then it's time to take some profits.

For the bearish crowd out there, its worth noting that Verizon has typically traded with high correlation to the market. Over the past year, however, VZ is up 22% versus the Dow at up less than 2%.

Earnings multiples are indicators of the future expectations of the company. Arguably I am completely wrong on Verizon. There is a decent argument to be made, that with its legacy wireline businesses representing a far smaller share of the company's earnings, the multiple today is more indicative of the growth in wireless to come. I get it. But the multiple still seems high relative to the growth rate.

If the company grows by 7%, hits their numbers next year, it is quite possible that Verizon trades back to a 15x average multiple of 2013 EPS (which is $2.79). That would imply $41.85 stock price.

Finally, I will leave the investor to consider swapping out of Verizon and into Vodafone. Below is a snapshot of the Cash Flow at Vodafone (VOD). The stock's FCF yield is a healthy 7.6%. Roughly 30% of the company's net cash comes from Verizon on an ownership adjusted basis. Seems like a better risk reward than the historically low FCF yield on Verizon of 5.6%.

Source

Source: By The Numbers: Time To Sell Verizon

Additional disclosure: Short VZ