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2016-08-22 07:03:40

and Verizon Communications Inc Last year, I bought shares of AT and Verizon as defensive income generating plays for a volatile market. I didn't expect either stock to rally, but shares of AT and Verizon respectively rose 18% and 6% over the past 12 months easily outperforming the S 500's 2% decline. But now that both stocks are sitting at multi year highs, is it too late for new investors to start a position? Let's take a look at both companies' valuations, tailwinds, and dividends to decide. AT currently has a P/E of 16, while Verizon has a P/E of 12. Both ratios are lower than the average P/E of 20 for the domestic telecom industry and the S 500's current P/E of 23. The Ray Ban RB3460 Aviator Flip Out Sunglasses Black Frame
Ray Ban RB3460 Aviator Flip Out Sunglasses Black Frame following chart of AT and Verizon's P/E ratios over the past five years also indicates that both stocks remain at fairly "cheap" historical levels. AT and Verizon both need to generate lots of free cash flow to fund dividends and buybacks. In 2015, AT free cash flow rose 60% to $15.9 billion, thanks to its acquisition of DirecTV. Verizon's free cash flow, excluding proceeds from tower sales, rose 40% to $18.8 billion last year. To ascertain how cheap AT and Verizon are relative to their FCF, we should use the EV/FCF ratio. The following chart reveals that both companies' EV/FCF ratios have spiked to multi year highs, although they have gradually declined over the past year. AT and Verizon's EV/FCF ratios have risen due to higher debt loads impacting their enterprise values. AT took on debt to finance its acquisitions of spectrum licenses and DirecTV, while Verizon spent billions on spectrum licenses and its purchase of AOL. However, revenue from DirecTV, new wireless customers in Mexico, and the potential divestment of Latin American assets should keep AT debt levels manageable. AT and Verizon both trade at around 13 times forward earnings, so both stocks are trading at a premium to their earnings growth potential. Over the next five years, AT is expected to grow its earnings 5.1% annually, which gives it a 5 year PEG ratio of 2.7. Verizon is expected to grow its annual earnings 4.5% during that same period, which gives it a higher PEG ratio of 2.9. AT has hiked its dividend annually for over three decades, while Verizon has done the same for nearly a decade. AT currently has a yield of 4.9%, while Verizon has a yield of 4.3%. Both payouts are significantly higher than the S 500's average yield of 2.1%. To many investors, income generating stocks like AT and Verizon only become "overvalued" when their price growth causes yields to dramatically decline. AT and Verizon's yields have indeed fallen slightly, but their 4%+ yields still remain above multi year lows. Over the past 12 months, AT has paid out 64% of its FCF as dividends, while Verizon has paid out 76% meaning that both companies still have plenty of room to boost their payouts. Are AT and Verizon overvalued? Whether or not AT and Verizon are overvalued depends on your perspective as an investor. Both stocks trade at a discount to the industry and overall market, but neither stock can be defined as a "deep value" stock which trades at a discount to its earnings growth potential. But if you're an income investor like me, AT and Verizon's hefty yields and rising cash flows remain impressive. Therefore, I think AT and Verizon are neither cheap nor expensive. Instead, I believe that both telco stocks are still "fairly" valued based on their earnings growth potential and dividend yields, and it still isn't too late for new investors to jump aboard. A secret billion dollar stock opportunity The world's biggest tech company forgot to show you something, but a few Wall Street analysts and the Fool didn't miss a beat: There's a small company that's powering their brand new gadgets and the coming revolution in technology. And we think its stock price has nearly unlimited room to run for early in the know investors! To be one of them.

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