AT&T: The End Is Near

Summary

• It is hard not to get concerned ads a shareholder when you see one of your largest positions getting hammered day after day.
• That is the way I feel about my AT&T position right now. The stock is basically a falling knife at this point.
• Furthermore, there could be more pain ahead as the company is on the midst of a major spending spree just as the wireless wars heat up.
• In thefollowing piece we take a closer look at what lies ahead for the company andthe stock for concerned dividend growth and income investors.

No pain, no gain

This was a phrase frequently used by my drill instructor during my time in Army boot camp. The meaning of the phrase is suffering is necessary in order to achieve something great. That is the way I feel about my investment in AT&T (NYSE: NYSE:T) right now. The stock has now officially entered falling knife status.

Current Chart

Source: finviz.com

This reminds me of a famous contrarian quote by Seth Klarman:

“Generally, the greater the stigma or revulsion, the better the bargain.”

At present, AT&T’s stock is unloved and under-owned. The stock has broken through major support at the $38 and is within a few percentage points of its 52 week low. Even so, the question remains… Does AT&T’s stock represent a value trade or trap?

Value Trade Vs. Trap

You have to buy low to sell high and AT&T is down significantly. The question is… Does the selloff in AT&T shares represent a value trade or trap? A value trap is a stock that appears to be a bargain based on fundamentals but has no future catalyst for recovery.

The stock traps investors when they buy into the company at low prices and the stock never improves. Sometimes stocks are down for good reason. Sector, industry or company specific headwinds may be so strong and prevalent the company may never recover. In the following sections we will perform a review of AT&T’s current state of affairs to determine if the stock is a value trade or trap. We will first review the current fundamentals.

Fundamental Review

Earnings per Share

The earnings per share (EPS) of a company is conceivably the most important statistic to understand before investing in a company’s stock. Each and every time you consider starting a position in a stock, you should prudently scrutinize the earnings information for the company. The reason earnings are so vital to investors is because they tell you about the relative profitability of a company.

Even though the stock had sold off, it has not been due to EPS estimates being cut. EPS is defined as the net income of a company divided by the shares of common stock outstanding. With the earnings per share measure, you are looking at the amount of money left over for shareholders. The value is reported after taxes are subtracted, and we are "normalizing" those profits by stating them on a per- share basis.

Source: scottrade.com

What’s more, AT&T EPS 5-year growth rate is outstanding at 25.85%.

Source: scottrade.com

The 25.85% beats both AT&T’s peers and the S&P 500 by a wide margin. Moreover, the forward EPS growth rate of 7.25% is vastly higher than AT&T’s closest rival Verizon’s (NYSE: VZ) at 2.52%. Based on these facts, AT&T’s EPS underpins the fact the stock is a value trade, not trap. Furthermore, AT&T stand head and shoulders above the rest in regards to profitability.

Source: scottrade.com

The other positive fact is AT&T is still managing to turn a profit of approximately 8%. When a company is profitable, and has money to give back to shareholders in the form of earnings, the company has two basic options. It can distribute some of the earnings in the form of a stock dividend. Whatever is not paid out in the form of dividends is placed into the retained earnings, which then become a source of money, or capital, which can be used to help fund the growth of a company.

Based on the review of the company’s EPS data and profitability margins, the stock appears to be a value trade, not trap. But, is it the time to buy? The stock is definitely a falling knife.

How to catch a falling knife

Scrutinize the Relative Strength Index

The RSI Indicator is a good tool to help identify overbought/oversold conditions, divergences, and crossovers that investors use to identify new trends in a stock or the market.

An RSI below 30 indicates an oversold condition, acting as a warning to the investor to be ready to buy the best set ups. As the RSI indicator rises through 30, it gives a buy signal. This is especially true if the long-term trend is up, as the RSI rises through 30, creating potential entry points. These are bullish indicators regarding a stock's possible future performance. AT&T’s RSI currently stands at 31 and appears to still be on the way down. I see more downside ahead with earnings on the horizon.

The Bottom Line

There may be more volatility in front of us even with the more than 10% drop in the stock recently. Nevertheless, this may be a good point to start a position as it appears we may have reached the point of maximum pessimism. Fears of a high payout ratio, high debt to equity ratio have taken their toll on the stock. What’s more, uncertainty regarding the Time Warner (NYSE: TWX) acquisition and President Trump’s pro-growth policies coming to fruition haven’t helped much either. Nevertheless, as Warren Buffett says, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.” The key to buying into a stock that is in free fall is to wait for a definitive trend reversal and/or layer into the position over time. The stock is trading for a bargain price at present. Nonetheless, there may be more downside ahead and the trend is showing no signs of reversal. For those with a high risk tolerance, starting a quarter position prior to earnings may be appropriate. For those with a low risk tolerance, I would wait for a trend reversal to be completed. The current yield of 5.32% provides an additional margin of safety at present as well. Basically, AT&T is on sale right now, but it still may get even cheaper so take your time building a full position. Please use this information as a starting point for your own due diligence and consult an investment adviser prior to making any investment decisions. Those are my thoughts on the matter. I look forward to reading yours.

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The true value of my articles is derived from the prescient observations of Seeking Alpha members in the comments section below. Do you believe AT&T represents a value trade or trap at current levels? What are your thoughts on the stock’s price going forward? Thank you in advance for your participation.

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Analyst’s Disclosure: I am/we are long T. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.