Verizon’s dividend yield appears to be too good to be true. Is it?
Dividends are an appealing reason to purchase a stock. After all, it’s good to get compensated solely for the possession of something. When looking for high-yielding stocks, three industries frequently come to mind: utilities, real estate investment trusts (REITs), and telecommunications. These companies typically have relatively steady cash flows, allowing them to pay shareholders a higher-than-average dividend.
Verizon Communications (VZ -1.32%), the second-largest carrier behind AT&T, is among the telcos. The stock has an appealing 6.89% dividend yield, but it is also in the red-flag zone. When a stock’s dividend yield exceeds 5%, it is sometimes interpreted as a warning indication that the firm will be unable to meet its dividend payments in the long run.
Should Verizon stockholders be worried? Is there any explanation for its high yield?
Another consideration with Verizon
Verizon’s stock has had a difficult year, falling 22% this year, trailing the S&P 500 index. Surprisingly, much of Verizon’s downfall has little to do with the company. Instead, the Federal Reserve is to blame for many of Verizon’s problems.
Treasury yields have climbed as the Fed raises interest rates to slow the economy and tame inflation. A two-year note, for example, can yield 4.5%, whereas a 20-year bond can yield 4.2%. That is guaranteed revenue as long as the United States government does not default on its obligations. So, as an investor, would you rather buy a Treasury with a guaranteed 4.2% dividend or a stock like Verizon with the same return but the risk that the company would fail or lose market share?
It’s not a difficult decision, which is why Verizon’s stock has dropped while Treasury rates have risen.
When it comes to dividend yields, though, the two are perfectly in sync.
If the dividend distribution remains constant, the yield has an inverse connection with the stock price. As a result, as investors traded out of Verizon stock to buy Treasuries, the yield increased.
Assuming that increasing Treasuries rates prompted the yield on Verizon’s stock to jump, does this make Verizon a screaming buy with its bloated dividend? Let’s start with the payout ratio.
Verizon’s payout ratios are satisfactory.
The payout ratio calculates how much of a company’s earnings are distributed to its shareholders. It is unsustainable if this level approaches 100%. However, it should be lower so that the company can keep earnings to pay down debt, buy other enterprises, or save for a rainy day.
Verizon’s earnings are in line with its historical standards.
The payout ratio can also be calculated using free cash flow. Of course, it’s always a good idea to double-check both techniques, because differing reporting systems can be deceptive. If, on the other hand, both the earnings and free cash flow methodologies agree, the company is most likely in a good position.
Fortunately for Verizon investors, the free-cash-flow technique implies that the company is in good shape, but investors should keep an eye on this trend.
While Verizon is in fantastic shape, investors should keep an eye on the payout ratio. However, because free cash flow can be variable, investors should expect a little more volatility.
Even though Verizon’s dividend yield appears questionable, the business behind it is still operating, and the stock’s behavior is most likely due to what is going on in the Treasury market. If the Federal Reserve lowers interest rates and investors are no longer able to buy high-yielding Treasuries, Verizon’s stock may experience a burst of renewed interest, bringing the price up and the yield down.
If you invest now, you may lock in that dividend payment and have a long-term impact on your portfolio’s income. However, keep in mind that Verizon is a business, and if it loses market share or begins to fail, the dividend yield may suffer, unlike US Treasuries when held to maturity.
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