On March 21st of 2011, I had a limit buy order for shares of AT&T (T) at a cost basis of $28.66. Incidentally, this was the first trading day after AT&T announced that it would acquire T-Mobile from Deutsche Telekom. I can now tell you that only one of these purchases went through. At the time of my purchase, AT&T paid a quarterly dividend of $0.43 for a current yield of 6%. I would like to specifically indicate that I did nothing that spectacular at all by purchasing shares at this time and price; I claim no great insight into the market's movements, especially in the short term. But if you happen to know where T trades today, you might know where this article is going. So why did I purchase shares of AT&T in 2011? That's a good question and I'm glad you asked.
As a dividend growth investor, my primary concern is a growing stream of income over time. Not just growing, but growing by a rate that outpaces inflation so as to increase my purchasing power. AT&T had increased its dividend for 27 straight years as of March of 2011. Now, obviously historical performance doesn't tell you much about future endeavors. But I would argue that dividend increases are much stickier than price movements or even earnings. Thus there is a propensity, or at the very least a vested interest, in increasing the dividend moving forward. So I was comfortable that AT&T would increase its dividend, if possible, moving forward.
Next, it's important to consider the rate by which the dividend is increasing. After all, a company like Consolidated Edison (ED) has increased its dividend for 38 straight years, but these increases have come in the form of just a 0.9% annual growth rate over the last decade. In 2011, we would have seen a 10-year average yearly dividend growth rate of just over 5% for AT&T - covering inflation, although not spectacularly. It is true that as of late these increases have been more lackluster, but it should be noted that the immense current yield (6%) at the time more than made up for the lack of growth in the short term.
Of course, the natural indication of whether a company is able to continue raising its payouts is whether or not the company is sustainable. In a 2011 poll, a TeleNav survey found that about 1 in 5 Americans would rather give up their toothbrush or go shoeless for a week than give up their cell phones for a week. This doesn't indicate that AT&T specifically is sustainable, but it is noteworthy to indicate that cell phones don't appear to be going away anytime soon. And if it were mathematically rational to bet, I would bet that AT&T will continue to benefit from this.
Obviously, there was more to my research than just these three suppositions, but in reality, one would already start to feel comfortable with an investment in AT&T. After all, in 2011, T had a well-above average current yield, an inclination to increase its payout and a seemingly maintainable, if not growing, market demand. By the way, I use Sprint (S) and some swear by Verizon (VZ). Perhaps, arguments can be made for a different mobile provider (or holding a few for that matter), but partnering with a 6% growing yield moving forward seemed like a pretty rationale move for an income-conscious investor.
So where am I with my AT&T investment today, a year-and-a-half later?
From March of 2011 until the end of the year, I collected three $0.43 dividend payouts or $1.29 a share in 2011. In the beginning of 2012, AT&T was nice enough to boost my annual income by 2.3% to $0.44 a quarter. Now obviously, I would have enjoyed a larger increase, but it is an increase. This brings my 2012 total to $1.32 a share for a grand total of $2.61 in the last year and a half. This November, I will surely receive another $0.44 a share, but we'll leave that out until it's actually in hand.
It should be noted that I let these payments aggregate, add them to my other dividends and reinvest - although not necessarily back into AT&T. If you take the $2.61 worth of dividends divided by the cost basis of $28.66, we find a 9.1% return in the last year and a half - or slightly over 6% annually. To be perfectly frank, this is a reasonable return on its own, however we have not yet considered capital appreciation. This is something that I am not necessarily focused on, but need to consider nonetheless.
As I write this, T trades at about $38.30; or more specifically at a 33.6% premium for what I paid. Add in the dividend gain and we find a total year-and-a-half return of about 42.7%. That's about 26.75% on an annual basis. Incidentally, if I could find that type of return on a consistent basis, I likely wouldn't be writing here on Seeking Alpha - but as indicated, I claim no special knowledge about short-term price movements.
So here's the dilemma I face today: Should I continue to hold AT&T with my initial investment thesis in mind, one that I would have been perfectly happy with if T had stayed near 29 bucks or even dropped in price, or should I bring the paper gain to realization and invest in something more productive? To be sure, I don't have a precise answer, but I have given it reasonable thought before.
I would need to find an investment that not only replaces my growing income stream, but also is at least as wonderful a company as I perceive AT&T to be, of which it must be said, this status can be highly debated.
Let's address the probability of finding a better income stream. Within current dividend growth companies, Coca-Cola (KO), PepsiCo (PEP), Johnson & Johnson (JNJ) or Procter & Gamble (PG) for example, one isn't likely to find too many 6%+ yields. In fact I found just two companies on David Fish's Champion list with a yield above 6%.
Now to be sure, one doesn't need a 6% yield to generate the same amount of income. AT&T currently yields 4.6%, which would be a bit closer to the huddle rate - although I would express two cautions. First, taxes on capital gains might have to be considered and thus would mitigate a portion of the perceived income boost. Second, even a 4.6% yield is difficult to consistently find amongst the companies that you truly want to own. However, there is a reasonable case to be made about the relatively low expected future dividend growth rate of AT&T as compared to its DG counterparts.
Let's compare the likes of say Target's (TGT) 2.25% current yield growing at 11%, Johnson & Johnson's 3.5% yield growing at 8% a year and my AT&T yield of 6% growing at 3% a year, for the next 20 years. Now admittedly there is a great sensitively involved here in both forecasting rates this far and assuming constant gains. But that doesn't mean that simple scenarios aren't useful.
|Yearly Income||Year 1||Year 5||Year 10||Year 15||Year 20|
Here I assumed an initial investment of $10,000 and grew each yield at the corresponding rates. Granted, volatility and future expectations would have to be taken into consideration. We see that in the first 10 years, AT&T provides more nominal income in every year. Note that these values indicate yearly income and not aggregated income, but it follows that AT&T would provide more dividend income during the in-between years as well.
It isn't until the 13th year that we see JNJ pass T in yearly income. In year 15, we see that both JNJ and TGT are providing more income. By the end of the time period, the higher growth rate eventually wins out and TGT is providing a substantial amount of income. However, we have not yet considered the value of aggregating the dividends.
|Aggregate Income||Year 1||Year 5||Year 10||Year 15||Year 20|
Here we see that AT&T provides more total income throughout the entire 20-year period. Furthermore, these are nominal comparisons, but the higher payouts in the beginning would likely add even greater value to the AT&T payouts. It's noteworthy that a much higher yield takes precedent over a reasonable yield and much higher growth rate.
So, based on the reasonable assumptions and likely next best alternatives, it appears that one would have a difficult time finding a better replacement income provider. I'm not saying impossible, but I am simply suggesting there would be difficulty. Additionally, one would need to ensure that any difference in their future income stream is compensated by the robustness of the underlying security. That is, one doesn't want to sacrifice a growing AT&T payout simply for additional funds in any old company, and certainly doesn't want to take less income by investing in an inferior company.
In holding AT&T for the long term, one can feel reasonably confident that the current yield will be maintained in relative range. More specifically, while it is possible the market might offer AT&T with a 12% yield, this doesn't seem overly likely. Over the last 10 years, AT&T has had a current yield between 3.3% and 6.9%.
Truthfully, this is quite a wide range, but I feel fortunate for having bought shares near the upper portion of this array. If we expect AT&T to have a current yield in the 3.5% to 6.5% area in the future, what does this mean for my holdings? Well, if we moderately assume 3% dividend increases going forward, this leads to a relatively lasting realization. Let me explain.
While the current stock price run-up could certainly be seen as a selling opportunity, it doesn't necessarily preclude one from future gains. For example, if the current $1.76 dividend is raised by 3% for five years, this would turn into a yearly payout of $2.04. Keeping the current yield at 4.6%, this results in a price appreciation to $44.35 or a yearly rate of 3% as well. Not to mention the 5%+ yearly gain from dividends.
Extrapolating the above a bit, if T is able to grow its dividend at 3% a year for 20 years and the current yield remains at 4.6%, this indicates an 80% price appreciation, or 3% a year. If the yield happens to drop to 3.5%, the average yearly return jumps to 4.4%. Even if the yield goes back up to 6.5% in twenty years' time, this indicates a 1.2% yearly price appreciation. And keep in mind that these price appreciations aren't the focus, the dividend is; they just happen to tag along for the ride anyway. More succinctly, if the dividend keeps growing, then capital appreciation will come.
The bottom line for me is this: while it might be tempting to take the gain, in reality I likely would want to own the company for many years to come. And this point is regardless of where the price may or may not go. I'm predominantly focused on the income that AT&T provides and the sustainability of its market. Both appear just fine for the moment. Of course, this is something that must be monitored through time. Furthermore, if I was concerned about AT&T's market price (which I'm not), I could take solace in the fact that it will likely trend upward anyway, whether I would like it to or not.
Finally, I fundamentally believe that T will likely compliment, rather than compete with my other dividend growth stocks. In fact, I have already proven this by using the AT&T dividends to add to or initiate in other DG positions. In this way, while a short-term upside might seem like an enticing opportunity to take advantage of, I don't fundamentally recognize it as being all that different from a short-term price decline.