It's been a while since I've written an article about AT&T (T). Today, I'm going to look at two ways Warren Buffett might value the company. Then, I'm going to give you tell what this means for investors.
Back in 1998, the American Association of Individual Investors ran an article about investing like Warren Buffett. It was loaded with the usual stuff. For example, when you invest in a stock, you're investing in a business. Also, that Buffett likes consumer monopolies with a strong upward trend in earnings, conservative financing, high return on shareholders' equity, and the like.
Obviously, AT&T isn't a wonderful fit. I doubt we'll hear that Buffett has suddenly jumped on the "T" train.
- EPS has mostly been flat or barely growing.
- ROE has generally been positive but spotty.
- Debt is kind of insane now at $180B (but cash flows are strong).
There's not much need to look at the exact details here. I'm not trying to say that Buffett would buy AT&T or that there's a fit. Instead, I'm using crayons to create a simple cave painting, so we can move into valuation. Let's carry on.
Valuation Method #1
We're going to take AT&T's EPS and divide that by the long-term U.S. government bond rate.
Let's say we're working with $3.50 for the EPS. That should rise to $3.55 or even $3.60 in the next year and might even reach $3.70 or $3.75 by 2020. But, to be a bit more conservative, we'll use $3.50 for our EPS.
And, for the long-term U.S. government bond rate, let's use the 10-year rate, which lands right at about 3%. The 30-year rate is about 3.3%.
Now, the simple math is $3.50 divided by 3% (i.e., 0.03) giving us:
And, if we run the math with the 30-year rate of 3.3% (i.e., 0.033), we get:
I think this is pretty incredible, given that AT&T is trading at just over $31 right now. And, this is after a moderate run up in 10-year rates from about 2.5% in early 2018. And, for 30-year rates, the run started around 2.8%.
In any case, using valuation method #1 we're looking at a value of around $117 per share.
AT&T stock was valued at around $60.00 per share in mid-1998. The company's 52-week high was $68.50, and its 52-week low was $34.00 per share. The company's earnings per share (EPS) in 1997 were $2.79, compared to $3.60 in 1996. As of mid-1998, earnings per share were $2.96.
Note: The 10-year in 1998 started around 5.5% and dropped to about 4.7%, whereas the 30-year started around 5.8% and dropped to about 5.1%.
Valuation Method #2
I'm going to look at another approach used by Buffett. We're going to project the annual compound rate of return based on historical earnings. We'll look back 10 years.
I'll warn you in advance that this is messy. It's far from absolute or concrete. The earnings are very lumpy.
That all said, the 10 years include 2009 through 2018, giving us a compound annual growth rate of 5.11%.
Please remember that this is earnings per share or "EPS" and doesn't include any discussion or deep dive on debt, the dividend, or anything else. We're strictly using the brain-dead simple EPS starting point of $2.12 and reasonable 2018 estimate of $3.50 for this calculation.
Next, we take our current $3.50 EPS calculation for 2018 and see what happens over the next 10 years at 5.11%. I'll round down just a bit and use 5% over the next 10 years.
So, we're looking at just over $44 in earnings in 10 years. That's useful to know, but more importantly, we know that we're looking at about $5.40 in estimated earnings after 10 years, given the 5% EPS growth.
Lastly, for Method #2, we're going to take the $5.40 and multiply by the average low P/E and average high P/E for AT&T over the last 10 years.
Trying to get an accurate "lowest" and "highest" P/E ratio over the years is easier said than done. Plus, it's not necessary to be perfect here. After all, this is to create a range using probabilities. To keep it simple, I'm using a P/E of 8 for the low and P/E of 16 for the high.
For the low, using the P/E of 8, we get a starting value of: $43.44
For the high, using the P/E of 16, we get a starting value of: $86.88
However, an estimate of dividends paid over the 10 years is added to the price. Here are those estimated dividends assuming a conservative 2% increase per year:
Therefore, we take $43.44 (P/E average of 8) and add $21.90 to arrive at a value of $65.34 per share.
And, we take $86.88 (P/E average of 16) and add $21.90 to arrive at a value of $108.78 per share.
Interestingly, the higher value of $108.78 is pretty close to the Method #1 value of about $117.
Valuation in Perspective
So, with Method #1, we landed at a value of around $117. And, with Method #2, we landed in a range from $65 to $117. Given these two methods only, and with very simplistic assumptions, we're looking at a "Buffett Style" Value Range from $65 to $117.
I am inclined to drag these numbers down significantly for several reasons.
- Huge debt load
- AT&T and Time Warner merger
- Historically low treasury yields
- Relatively high S&P 500/market valuation
- Lumpy/flat EPS over the years
There's plenty more to worry about. Then again, there's always something to worry about. I also doubt that Warren Buffett sees enough value in AT&T. It's not really a candidate. If nothing else, I'd say it probably falls into the "Too Hard Pile" although I don't know.
Regardless, it's still useful to use two of Buffett's valuation systems to determine intrinsic value. It's also instructive to see a current price of just over $30 but then see a valuation range of $65 to $117.
We're looking at a "sale" between 50% and 70% for AT&T right now.
To me, that provides a moderate level of comfort, given the transformation happening right now. To that end, if you're buying AT&T right now, or thinking about it, then it appears that you have a reasonable margin of safety.
Furthermore, if you're holding on AT&T right now, you're getting a historical high yield of well over 6%. In my book, that means that every dividend payment reduces your risk.
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.