Despite the company’s flaws, the stock could become attractive to some investors as interest rates fall.
For most of the past decade, Verizon Communications (VZ 0.44%) has given shareholders little to cheer about. The stock has severely underperformed compared to the broader stock market. But things have changed over the past 12 months. Verizon outperformed the market, with a total return of 45% versus the S&P 500’s 34%.
Verizon is doubly benefiting from the prospect of lower interest rates. The company borrows frequently and has a large amount of debt on its books, so lower interest rates would help reduce interest expenses. Additionally, as the interest rates offered by savings accounts and low-risk interest-bearing assets decline, income-seeking investors will naturally gravitate towards high-dividend stocks like Verizon.
The question, of course, is whether Verizon is a buy right now. Was Verizon’s rebound from a 10-year low in 2024 the start of something great, or just a blip?
Verizon is struggling to increase profits.
The telecommunications industry is a wide moat industry, making it difficult for new competitors to enter the field. The U.S. telecommunications industry is dominated by a few powerful companies, including Verizon, AT&T, and T-Mobile US, which merged with Sprint in 2020. Companies spend billions of dollars annually building and maintaining wireless network infrastructure.
Companies in the wide moat industry typically have some pricing power that can drive growth and make good investments. However, Verizon, America’s leading wireless carrier with about 37% of the market, has struggled with revenue growth for three main reasons.
First, it has less pricing power than expected. All three major U.S. carriers offer nationwide service, so consumers often switch to the cheapest carrier. Second, the market is saturated. Most Americans now own a smartphone, and many also own other wireless devices, such as smartwatches. There is little substantive growth left to pursue. Finally, wireless businesses require billions of dollars in infrastructure investment each year.
Verizon’s non-GAAP earnings per share were $3.35 in 2014 and $4.71 in 2023, a total increase of 40% over 10 years. During that time, America’s money supply increased by about 88%. In other words, Verizon’s revenue appears to have grown more due to inflation than anything else. Management has said it plans to keep adjusted earnings between $4.50 and $4.70 per share this year, suggesting that profits could decline. Analysts expect earnings to grow at an annual rate of 2.4% over the next three to five years.
Verizon’s good points
The lack of meaningful growth helps explain why this stock has generated poor investment returns over the years. However, it’s not all bad. Verizon’s generous dividend yield is 6.2% at the current stock price. This is much higher than the S&P 500’s current yield of 1.3%, and much better than the interest rates you can earn on high-yield savings accounts.
This makes Verizon more attractive to those looking to earn investment income.
Most importantly, the payments appear to be secure by most standards. At current levels, Verizon can cover its dividend with free cash flow alone, with about 20% remaining. Dividends account for only 59% of Verizon’s estimated 2024 net income. Verizon’s earnings have been fairly stable, which should provide some peace of mind for those who rely on the dividend. Additionally, Verizon has increased its annual dividend for 20 consecutive years.
Even if dividends are your primary goal, you don’t want to suffer a large loss on your principal. That’s part of Verizon’s appeal. It is a stable stock with a beta value of just 0.4. This means that the stock’s volatility is much lower than the overall market. So while Verizon typically doesn’t rise as much when the market is strong, it probably won’t fall too fast when the market crashes.
Is Verizon’s price reasonable?
The caution with Verizon is not to overpay for the stock, as earnings growth has been very slow and the outlook isn’t bright. As a reminder, analysts expect Verizon to grow its earnings by an average of 2.4% per year over the next three to five years. It may not even keep up with inflation. And as the stock has soared this year, that valuation is much different than it was a few months ago. Verizon’s 2024 earnings forecast is more than 9 times that, compared to just 6 times a year ago.
Earnings growth alone doesn’t justify Verizon’s valuation. The stock has a price-to-earnings (PEG) ratio of 3.9, and I generally don’t buy stocks with PEG ratios above the 2.0-2.5 range. But the economy appears to be entering a period of lower interest rates, which could lead the market to increase valuations for high-yield stocks like Verizon.
Verizon’s current valuation creates a risk that total investment returns will slow, but that could deter those more interested in cash from dividends. Verizon remains a strong choice for income-seeking investors, but everyone else is better off looking elsewhere for better opportunities.
