Verizon Likely Over-Extended For The Short Term

| About: Verizon Communications (VZ)
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Don't get me wrong, in the long term, I am bullish on Verizon Communications (NYSE:VZ); however in the short term, it looks like the company's stock price has over-extended itself. Since April, Verizon has been rallying relentlessly without taking a break. The stock price rallied from $37 to nearly $44 in the last 3 months, representing an upside movement of 19%. This would be impressive at any given time, however it is even more impressive when it happened over a time period where market hasn't been performing that greatly.

Since Verizon's rally has started, Dow Jones Industrial Index (NYSEARCA:DIA) has been down by 2% and S&P 500 Index (NYSEARCA:SPY) has been down by 3% whereas Verizon has been up by nearly 20%. Given the company's beta of 0.49, it is interesting to see Verizon overperforming the market by a large margin.

In the last 12 months, the company hasn't performed that impressively, mostly due to contracting margins as the company subsidized millions of Apple iPhones for its contracted clients. The company was able to earn 93 cents per share in the last year, giving it a P/E ratio of 47. This year, the company is expected to earn $2.51 per share and the next year, it is expected to earn $2.81 per share. According to these numbers, the company is looking at a forward P/E ratio of 17 by the end of this year and 16 by the end of next year. The average P/E ratio in telecommunications is below 15 and it is expected to be about 14 by the end of next year.

In the last year, the average analyst price target on the company increased from $36 to $37 and currently it sits at $40, which is nearly 10% below its current price. Keep in mind that analyst targets usually reflect a stock's share price 12 months after the date of prediction. By the time $40 price target was set, the company's share price was around $38 and now they seem a little bit over extended.

Verizon's revenue tends to grow relatively slowly. For example, the company generated revenue of $107 billion in 2009, $106 billion in 2010, $110 billion in 2011, and its revenue is expected to be near $115 billion this year and $120 billion next year. Any possible income growth will mostly come from margin improvements for the company and there is a limit in how much improvement a company can squeeze in its margins.

Verizon is good at paying dividends. The company has a yield nearing 5% and it has been raising its dividend rate for a quite a while. Dividend investors can find a lot of value in this company. In the last 12 months, the company paid $1.99 per share in dividends while earning only $0.93. Based on the company's forward earnings estimates, it will have a payout ratio of 79% by the end of this year and 71% by the end of next year even if the company doesn't raise its dividend rate. This could be difficult for the company to support in the short term.

Those looking for an entry point for Verizon should wait for a pullback. I would wait until the stock price drops to below $40 a share. On the other hand, I wouldn't suggest shorting this stock either. A stock can go up for no reason for a long time as we've seen in the case of Chipotle (NYSE:CMG) and Amazon (NASDAQ:AMZN) last year. Those looking for current income may get in any time as the company's dividend yield isn't likely to go away anytime soon. The company is obviously committed to having a high dividend yields.

Disclosure: I am long VZ.