AT&T Inc. (NYSE:T) and Verizon Communications (NYSE:VZ) are two mega-cap giants that dominate the telecommunications industry in the United States. Both companies have seen robust subscriber and earnings growth in recent years and their stocks have risen to multi-year highs this summer. Both have capitalized on the robust growth in smartphones that buoy data sales. However, AT&T pays the highest dividend yield among the Dow Jones Industrial Average index constituents and the third highest among the S&P 500 Dividend Aristocrats. At 4.7%, its dividend is higher than Verizon's 4.5%. Does this mean that AT&T is a better dividend stock than Verizon Communications?
A closer look at total returns of the two stocks will shed more light about which company performed better as dividend investment over the past ten years. Ten years ago, AT&T had a dividend yield of 5.2%, while Verizon boasted a dividend yield of 5.6%. Over the following ten years, AT&T increased its dividend at a 5.1% average annual rate, while Verizon boosted payouts at an average rate of 2.6% per year. In the observed ten years, AT&T's total return averaged 9.3% per year, while Verizon's total return averaged 9.6%. Hence, despite a lower dividend growth rate, Verizon was able to outperform AT&T over the past ten years.
The same outcome prevails based on a five-year investment horizon. Despite a slower growth in its dividend over the past five years, Verizon still beat AT&T in terms of total returns. Over the past five years, Verizon recorded a 4% annualized growth in its dividend, which compares to a 4.4% annualized growth in AT&T's dividend. Over the same investment horizon, Verizon returned 6.2% per year, while AT&T returned 4.3%. Hence, dividend investors who held Verizon shares for five and ten years and liquidated them did better than dividend investors who invested in AT&T stock over the same investment periods.
Over the past five years, Verizon posted smaller annual average declines in its EPS compared to AT&T. Hence, Verizon's EPS contracted at an average rate of 14.7% per year, while AT&T's EPS shrunk at an average rate of 18.8% over the past five years. Despite the sizable contractions in their EPS, both stocks generated returns that outperformed the total return of the S&P 500 index over the noted five- and ten-year periods. Over the past five years, Verizon's P/E averaged 30, while AT&T's P/E averaged 20.6. Although small in comparison to other companies, Verizon's return on invested capital (ROIC) of 3.4% is higher than AT&T's at 2.4%.
Going forward, both companies will likely continue to raise dividends at similar rates to those in the past, although Verizon will be in a better free cash flow position that may warrant a higher dividend boost. According to a recent article in the Wall Street Journal "analysts at Macquarie say Verizon shareholders could see a one-time, 10% increase in the dividend in 2013 or 2014. AT&T is more likely to continue with its regular but more-sedate pace of dividend increases." Apparently, the reason for this is that "Verizon's (free cash flow) is expected to climb 29% in 2013 and 14% in 2014, versus expected declines for AT&T of 2.4% in 2013 and 1.1% in 2014." Verizon's payout ratio stands at 42% of free cash flow and AT&T's is at 72%.
While AT&T's forward P/E of 10.8 is lower than Verizon's forward ratio of 14.7, Verizon is trading at a premium given that its EPS growth is forecast to be higher next year. Analysts at Macquarie Securities believe that "AT&T's profits will shrink this year as the company upgrades more handsets, even as it continues to lose market share to Verizon." In the meantime, Verizon has reported a record-high margin (the best in industry) and a strong, double-digit growth in service revenues. Moreover, the company has been reporting nearly three times as many contract subscribers as AT&T, which adds to the future revenue and EPS growth. For the time being, analysts see the EPS growth of both companies averaging slightly over 9.0% per year for the next five years.
AT&T and Verizon are telecom behemoths that stand to benefit from higher adoption of smartphones and penetration of internet traffic. AT&T's dividend is almost guaranteed and is likely to see higher, albeit modest, payout boosts as the company maintains its prestigious credential of dividend aristocrat. At the same time, Verizon is strongly positioned for future dividend growth. Both companies are enjoying support from the world's largest hedge funds. Adage Capital and Cliff Asness' AQR Capital Management are bullish about both Verizon and AT&T. Billionaire Ken Griffin is also a big fan of AT&T, while billionaire Ray Dalio holds a new stake in Verizon. We like consistency in dividend growth and cheap price multiples. That's why we prefer AT&T over Verizon. However, we think both of these stocks are good choices for long-term investors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.