Written by Robert Kovacs

Introduction

Sam: Hey Dad, what are you up to?

Me: Working on an AT&T (T) article.

Sam: Again?

Yes again.

AT&T is currently trading at only $27.87 and yields 7.46%. This yield is insane. There is no reason why AT&T should yield so little.

Just a couple of years ago, it was still believed that such yields were only reserved to companies which were likely to cut their dividend. Not to companies like AT&T.

Source: Open Domain

In fact, I believe AT&T to be trading at a fair price when it yields 5.5%. I believe it to be a bargain when it yields at least 6%.

It goes without saying, that with a yield like 7.5%, I’m in.

But I’m not just yield chasing. I never do that, as you know if you’ve been reading our stuff for a while.

There is no reason why AT&T should trade 35% below fair value. This article will explain why I believe AT&T is the ultimate value stock.

Our MAD Scores give T a Dividend Strength score of 93 and a Stock Strength score of 71.

I believe that dividend investors should buy T at these prices. The market is wrong.

Source: mad-dividends.com

As has become customary, I’ll go through the stock’s dividend profile before considering its potential for capital appreciation.

The reason we structure our articles this way is to first validate a stock as a good dividend investment. As dividend investors, this is what we care about. Once that is done, we evaluate the investments merits based on value, momentum and quality.

Dividend Strength

Our concept of dividend strength embodies the two aspects an investor should care about when analyzing a dividend stock:

  1. Is the dividend safe (dividend safety)?
  2. Is the dividend growth potential attractive relative to its current yield (dividend potential)?

Once again, the order is intentional. We first analyze dividend safety, to ensure that we are only investing in companies with safe dividend stocks. Only after, do we validate if the dividend potential is good. For more on dividend potential, read our article on How you can retire on dividends forever and ever.

Dividend Safety

AT&T has an earnings payout ratio of 128%. This looks bad right? A worse payout ratio than 85% of dividend paying stocks! Yet it isn’t that bad.

The reason it isn’t that bad, is because dividends are paid from cashflows, not from earnings. Where do you see the dividend factor in the income statement? You don’t. That’s because dividends are a movement of cash, whereas earnings include many non cash items. For T, its non-cash impairments and amortization of intangibles amounted to more than 3.3x the dividend. Again this is not cash leaving the company.

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“Dividends paid”, appears as a cashflow statement item. And T pays only 34% of its operating cashflow as a dividend. Of course, T is highly capital intensive. When you look at free cashflow, T pays out 83% of it as a dividend.

In over words, T can afford its dividend.

30/06/2016

30/06/2017

30/06/2018

30/06/2019

30/06/2020

Dividends

$1.90

$1.94

$1.98

$2.02

$2.06

Net Income

$2.34

$2.13

$5.13

$2.36

$1.62

Payout Ratio

82%

92%

39%

86%

128%

Cash From Operations

$6.16

$6.35

$6.30

$6.76

$6.17

Payout Ratio

31%

31%

32%

30%

34%

Free Cash Flow

$2.07

$1.87

$1.86

$2.85

$2.48

Payout Ratio

92%

104%

106%

71%

83%

Source: mad-dividends.com

As you can see in the chart and table above, T has maintained steady op. cashflow and free cashflow payout ratios for the past 5 years.

Furthermore, T has an interest coverage ratio of 2.9x which is better than 44% of stocks. This level of coverage, while not overwhelmingly great, is nowhere near as bad as many claim.

Plus, management has been increasing the dividend for decades. Not years, decades. 36 years to be precise. Let me tell you one thing: the dividend isn’t going anywhere.

Management has the will and dedication to keep the dividend alive. And the company generates plenty enough cash to pay the dividend.

When you have those two elements, you have a safe dividend.

Dividend Potential

AT&T has a dividend yield of 7.46% which is a higher yield than 89% of dividend stocks. That includes all crackpot dividend stocks, which can’t afford their dividend. It includes stocks which don’t have clear dividend policies. Yet T offers a yield which is up there with the most lucrative stocks in the whole market.

Source: mad-dividends.com prototype

In his most recent article, “Sell, Sell, Sell: Why, When, And How”, Sam put together these charts which show T’s dividend relative to its historical range of yields.

Half of the time in the past ten years (the light blue and light pink), T yielded between 5.2% and 6%, with a median of 5.5%.

And for T, this range is very fair I believe: it becomes overheated when it yields around 5%, and undervalued when it yields more than 6%. Anything in between is fair.

Source: mad-dividends.com

And a 5.5% dividend yield, would indeed be fair given the dividend growth prospects.

The dividend grew 2% during the last 12 months which is in line with the company’s 5 year average dividend growth of 2%.

Source: mad-dividends.com

You can expect T to grow its dividend at this rate for the foreseeable future. The $0.01 hike once per year is likely not going to change.

This makes T a fair investment when it yields 5.5%. But it yields 7.46%, nearly 2% more! At such a yield, T’s dividend is fantastic.

Just consider this: If the market does not recognize that T is undervalued, that this yield is absurd, and decides that a 7.46% yield is fair for T, you would still want to invest.

If you reinvested the dividend each year at that yield, and that the dividend grew by 2% per annum, a $10,000 investment would generate $1,729 in dividends per year. You’d also have $23K worth of T (thanks mostly to dividend reinvestments).

Source: mad-dividends.com

The above chart illustrates this. The orange bar shows the dividends from the original $10K invested, the yellow shows dividends from the reinvestment of dividends.

T has phenomenal dividend strength.

Dividend Summary

T has a dividend strength score of 93 / 100. Not surprising really: the dividend is safe and well covered, with decades of history to back it up. The yield is insane and offers a great opportunity to dividend investors.

Stock Strength

One objection that I often hear when suggesting an investment in T is that: there is no capital appreciation in it.

And if you pay a fair price for T (when it yields between 5.2% and 6%), this might be true. But as we’ll cover in the value, momentum and quality sections, this might no longer hold at current prices.

Value

  • T has a P/E of 17.20x
  • P/S of 1.14x
  • P/CFO of 4.52x
  • Dividend yield of 7.46%
  • Buyback yield of 2.49%
  • Shareholder yield of 9.95%.

According to these values, T is more undervalued than 94% of stocks, which is incredible. Of course the buyback program has been suspended, but this doesn’t really have much of an impact.

T trades at a very small multiple of its operating cashflow, and of course offers this massive yield. Valuing a stable stock like T using the dividend yield as the guidance suggests that it could be undervalued by as much as 35%. Our value score tends to validate this.

Value Score: 94 / 100

Momentum

AT&T trades at $27.87 and is down -7.87% these last 3 months, is up 4.11% these last 6 months but remains down -25.88% these last 12 months.

Source: mad-dividends.com

The stock has severely underperformed the S&P 500 (SPY).

This gives T better momentum than only 27% of stocks, which is very worrying. T is a laggard in this market. This means that the market does not recognize T as a worthy investment in the current environment.

T can be as undervalued as you want, if the market doesn’t care, the price will go nowhere. I say this, because I usually avoid investing with momentum scores below 30, unless we are dealing with an All Weather dividend stock, AND I believe the market is wrong.

I believe this to be the case here. Yet it could take a long time for the market to appreciate this. Be prepared for sluggishness for a while.

Momentum score: 27 / 100

Quality

T has a gearing ratio of 1.8, which is better than 44% of stocks. The company’s liabilities have remained flat over the course of the last 12 months. The company’s operating cashflow can cover 12.5% of liabilities, in line with the median US stock.

Each dollar of assets generates $0.3 in revenue, which is better than 37% of stocks. This translates into 6.2% return on equity, which is better than 59% of stocks.

T depreciates 155.6% of its capital expenditure each year, which is better than 60% of stocks. T has a Total Accruals to Assets ratio of -9.5%, which is better than 49% of companies. These ratios suggest T’s quality is better than 64% of US stocks.

This really isn’t the story the stock chart is telling, which is why I believe the market is wrong.

People who worry about T’s debt, shouldn’t. T is a high quality company, which has been operating well within a difficult environment.

Quality Score: 64 / 100

Stock Strength Summary

When combining the different factors of the stocks profile, we get a stock strength score of 71 / 100 which is encouraging. The stock’s quality and valuation make it appealing, but the horrendous momentum suggests that not everybody agrees. I’m convinced enough to have this on the internet forever: The market is wrong about T.

Conclusion

With a dividend strength score of 93 & a stock strength of 71, AT&T is, in many ways, the ultimate value stock, and I believe, a great addition to any dividend portfolio at current prices.

While I don’t expect massive capital gains anytime soon, I wouldn’t be surprised at some point in the next 5 years, for an investment in T to be up 35%, without mentioning you get paid 7.5% to wait. I believe this makes it the ultimate value stock.

One last word

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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.



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