Should You Expect 9% Annual Returns From AT&T?

| About: AT&T Inc. (T)

Summary

Often commentaries will provide statements without the giving assumptions; for instance: AT&T is expected to return 9% annually.

Even when the underlying assumptions are provided, it’s frequently the case that these are limited to a single scenario.

This article allows the readers to make their own assumptions about the company to quickly reach an expected 5-year total return number.

If I were to tell you that I expected AT&T (NYSE:T) to have annual total expected returns around 9% over the next 5 years, you might believe that's sensible. Then again, you might want to know more about my underlying assumptions. The following commentary creates a baseline for how I came to that expectation. In addition, I'll provide two supplementary "valuation shortcuts" that allow you reach your own conclusion.

First, let's take a look at where shares of AT&T presently trade. At last glance, the share price was hovering just under $35 -- with a corresponding "current" dividend of $1.84 and underlying earnings power of $2.52. (Most websites indicate a higher number, but this is the trailing twelve-month number provided by the company, excluding significant or extraordinary items.)

Stated differently, shares trade a P/E ratio in the 13-14 range and have a "current" dividend yield of 5.3%. In reviewing data provided by S&P Capital IQ, these numbers appear to be in-line with the past decade and a half of data. The P/E ratio is perhaps slightly below "normal" and the dividend yield is slightly higher; but certainly shares have traded at more "extreme" levels. As such, one might expect a similar valuation in the future with the possibility of slight P/E expansion or yield compression.

Figuring out the future growth of the company requires guesstimates, so it's always prudent to remain somewhat cautious. Analysts an intermediate-term growth rate to be around 5%. Being somewhat careful, I'll suggest 3% growth isn't unreasonable.

Here's what the future dividend payments would look like under this assumption:

Year 1 = $1.90

Year 2 = $1.95

Year 3 = $2.01

Year 4 = $2.07

Year 5 = $2.13

Although the company's dividend growth rate has been slightly below this in the recent past, it's not exactly shooting for the moon, either. In total, this would represent $10.06 in expected dividend payments -- or roughly 29% of your original capital invested.

There are two easy ways to complete the expected total return calculation: using a future dividend yield or future P/E ratio. We'll use a dividend yield; say 5% in 5 years' time. The year 5 dividend payment is expected to be $2.13, which you divide by 5% to get a price target of $42.60. Add in the dividends and you come to a total value of $52.66 for a total expected return of almost 9% (($52.66/34.74)^(1/5)-1). If instead we were to use an end P/E value of 15, the results would be quite similar.

In short, if AT&T is able to grow its business by about 3% annually and its shares trade with a dividend yield near 5% or a P/E around 15, this would indicate total expected annual returns during the next half decade around 9%.

That's where most commentaries stop (if they even get to that point). They tell you the punch line -- AT&T might return 9% annually -- without also addressing other likelihoods. As I have previously done, I would like to correct for this by providing two tables that better illustrate the range of possibilities.

The first table uses expected dividend growth rate (on the y-axis) and expected end period dividend yield (x-axis).

5-Year Total Expected Return (with future dividend yield)

End Yield ->

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

7.0%

Div Growth

0%

15%

12%

10%

8%

6%

4%

3%

2%

0%

1%

16%

13%

11%

9%

7%

5%

4%

2%

1%

2%

17%

14%

12%

10%

8%

6%

5%

3%

2%

3%

18%

15%

13%

11%

9%

7%

6%

4%

3%

4%

20%

16%

14%

12%

10%

8%

7%

5%

4%

5%

21%

17%

15%

13%

11%

9%

7%

6%

5%

6%

22%

19%

16%

14%

12%

10%

8%

7%

6%

7%

23%

20%

17%

15%

13%

11%

9%

8%

7%

8%

24%

21%

18%

16%

14%

12%

10%

9%

8%

9%

25%

22%

19%

17%

15%

13%

11%

10%

9%

10%

26%

23%

20%

18%

16%

14%

12%

11%

10%

11%

27%

24%

21%

19%

17%

15%

13%

12%

10%

12%

28%

25%

22%

20%

18%

16%

14%

13%

11%

Here we can see the intersection of a 3% dividend growth rate and a 5% future yield equate to a total expected return of about 9%. I demonstrated how this math works above. However, what's nice about this table is that it allows you to view additional possibilities.

For instance, perhaps you thought my 3% growth assumption was reasonable, but believed shares of AT&T would instead trade with a yield closer to 6% in 5 years' time. In this case, the total expected return would be just 6% with very little capital appreciation. On the other hand, perhaps you thought the 5% dividend yield was fine, but expect the company to grow twice as fast. In this instance, you would have an expected return around 12%.

The second table provides a similar view, but instead of dividends uses earnings. Here we have an end P/E value on the x-axis and an estimated earnings-per-share growth rate on the y-axis.

5-Year Total Expected Return (with future P/E)

End P/E ->

11

12

13

14

15

16

17

18

19

EPS Growth

0%

1%

3%

4%

5%

6%

7%

8%

9%

10%

1%

2%

4%

5%

6%

7%

8%

9%

10%

11%

2%

3%

4%

6%

7%

8%

9%

10%

11%

13%

3%

4%

5%

7%

8%

9%

10%

11%

13%

14%

4%

5%

6%

8%

9%

10%

11%

12%

14%

15%

5%

6%

7%

9%

10%

11%

12%

13%

15%

16%

6%

7%

8%

10%

11%

12%

13%

14%

16%

17%

7%

8%

9%

11%

12%

13%

14%

16%

17%

18%

8%

9%

10%

11%

13%

14%

15%

17%

18%

19%

9%

9%

11%

12%

14%

15%

16%

18%

19%

20%

10%

10%

12%

13%

15%

16%

17%

19%

20%

21%

11%

11%

13%

14%

16%

17%

18%

20%

21%

22%

12%

12%

14%

15%

17%

18%

19%

21%

22%

23%

As alluded to earlier, a 3% growth rate with a 15 P/E would equate to 9% annual expected returns. Yet that's hardly the only possibility. What if the AT&T is only able to grow by 2% and has a P/E ratio of 13? That equates to a 6% annual expected return. How about a 6% growth rate coupled with a 17 P/E? Well, that would mean 14% yearly-expected total return prospects.

Now it should be underscored that the assumptions given here are simply that -- guesses about the future. Moreover, while I am using a 5-year timeframe, in reality I would be thinking about an investment decision in terms of decades -- it just so happens near-term forecasts are easier to formulate.

These valuation shortcut tables are provided as a baseline, a determination of whether or you should research further. If you believe AT&T will trade with a P/E around 11 or dividend yield in the 6%+ range, then there might be better alternatives out there. Alternatively, if you suppose shares will trade close (in valuation) to where they are presently, well, you might want to dig a touch deeper. After all, AT&T doesn't have to do anything that spectacular to provide reasonable returns.

In the end, I don't know what the business of AT&T or share price will do in the next 5 years and neither do you. However, what I do know is that using tables such as the ones above can give you a clearer picture as to what you might be able to expect. In making unknown (but largely profitable in the aggregate) decisions, the best we can do is come up with a ballpark figure, partner with what we perceive to be wonderful companies at reasonable times and keep our logical wits about us when all does not follow exactly to plan.

Disclosure: The author is long T.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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