This Is The Third Most Attractive Time To Buy AT&T In The Past Generation

| About: AT&T Inc. (T)

Summary

AT&T has only traded at a cheaper valuation twice in the past twenty years (during 2009 and 2010).

For every 100 shares of AT&T that you owned and reinvested since 2004, you would have an additional 70 shares today due to the power of reinvestment.

The recipe for success with AT&T is: buy at an attractive valuation plus reinvest the annually rising dividend each year.

When you enter the field of low-growth dividend investing, the valuation at which you establish an entry point is exceptionally critical because you don't have a high probability of "growing your way" into prosperity if you overpay. In the case of a high-growth business like Nike (NYSE:NKE) that is growing profits at 12% to 15% each year, paying a higher than typical P/E is not the end of the world because a few years of earnings per share growth may turn a potential mistake into a health gain.

That kind of flexibility does not exist when you enter the world of high-yield, low-growth income investments. If you overpay, you will spend years collecting dividends and then end up with negligible capital gains. AT&T (NYSE:T) is one of those companies where the price you pay has a very significant effect on the total returns that you will experience because the company has only grown its profits per share from $2.08 in 1998 to $2.55 in 2014. When profits only grow 22% in total over a sixteen-year stretch, you do not want to put yourself in a position where you will experience long-term P/E compression of any kind.

In 1998, people were paying over 20x earnings for shares of AT&T, which was a folly because of the low growth facing AT&T ahead. They achieved annual returns of 3.5% (less than the dividend!) over the past sixteen years because the P/E compression from 20 down to the 13x earnings range was a strong headwind that overwhelmed AT&T's 22% profit growth and dividend payouts over the past sixteen years.

But just because AT&T is a slow-growing company does not mean that it is a bad investment. Those $1.84 dividends, which currently amount to a yield of 5.6%, can really amount to something nice over time as long as you get your price right. For instance, from 2004 through 2014, AT&T created .7 of a share for every share of AT&T that you owned, due to the compounding effects of high reinvested dividends. Even though the price of the stock didn't move all that much between 2004 and 2014 (only going up about $5 per share), every 100 shares turned into 170 shares so that the dividend growth rate didn't fuel income growth nearly as much as the reinvestment of the dividend payouts.

What has caught my attention about AT&T recently is that buying shares of the company today no longer comes with the prospect of P/E compression; if anything, buying shares of AT&T at 13x earnings today sets you up for modest P/E expansion over the long run as the company drifts towards a long-term valuation multiple in the 15 range.

This is the third most attractive time to buy AT&T in the past generation: The only time you could have bought AT&T at a cheaper valuation came during the crisis-level years of 2009 and 2010, when shares of AT&T typically traded in a range of 11x-12x earnings. The returns when you buy AT&T at a low-ish valuation are quite nice for a slow-growing company: AT&T has returned 11.82% annually since 2009, and 12.13% annually since 2010.

Getting the valuation right is of central important to success with AT&T: the company carries $75 billion in total debt, has $56 billion in pension promises while only having $47 billion in pension assets, and has a dividend payout ratio of 72%. The company also does about $130 billion in revenue per year, which has been mostly static since 2008. In other words, you're not going to get significant earnings per share growth with this company, and the recipe for success is: buy at a good valuation, and reinvest the high dividend to perpetually boost your share count of AT&T.

The reason why AT&T is attractive is as follows: The telecommunications giant has lowered its dividend payout ratio from the 80%-90% range in the early 2000s to only 72% today. The P/E ratio has become more attractive, shifting from the 20x earnings range earlier in the 2000s to around 13x earnings today. And the profits are growing at a rate of 2%-3% annually, which when combined with the dividend and modest P/E expansion, ought to be enough for long-term 10% returns from here. The attractive part is that more than half of it is being supplied by the dividend alone.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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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