Source: PaxForex Premium Analytics Portal, Fundamental Insight
Low-beta stocks tend to be less volatile than the broad stock market, making them popular with conservative investors when the market gets choppy. U.S. telecommunications company Verizon Communications, however, has had an unusually volatile year. Despite a beta factor of just 0.3, the stock has fallen more than the S&P 500 in this bear market, 36% from its high and 24% over the past year.
Verizon's fall is not entirely undeserved, but we shouldn't be so quick to write off the stock this year. There is a lot of pessimism built into the stock's valuation, and there are legitimate reasons to be happy. In particular, we discuss below what makes Verizon a prime candidate for future recovery.
Verizon did not have a trouble-free campaign in 2022. The company lost decisively to competitors AT&T and T-Mobile in its core wireless segment. Verizon lost 16,000 wireless customers in the first nine months of 2022. But has the market been too hard on the company?
Over the past decade, Verizon's stock has traded at an average price-to-earnings (P/E) ratio of more than 12. Dropping the stock by almost half of its long-term valuation seems excessive, especially when you look at why most people hold Verizon stock in the first place is the dividend. Today, Verizon's dividend yield is 6.6 percent thanks to its lower stock price. For the year, the company paid out $8.1 billion in dividends and generated $12.4 billion in free cash flow, a 65% payout ratio.
With a reliable and generous dividend, you can count on growth. Even though the company lost subscribers last year, analysts still believe that Verizon will grow earnings per share by an average of 4% per year over the next few years. That's in line with Verizon's average earnings growth over the past decade.
With a robust dividend and steady earnings growth, there doesn't seem to be a significant factor that justifies a steep discount in the valuation of Verizon stock. That's normal; sometimes the stock market is irrational, usually more so in the short term than in the long term.
So what might lift Verizon stock? Interest rates have been rising rapidly through 2022, which may help explain the drop in Verizon stock. The company has $148 billion in long-term debt, and rising interest rates make the debt more expensive to borrow or refinance. Therefore, investors should keep an eye on Verizon's interest expense.
Investors should hope that the company's management will continue to allocate additional funds to pay down debt because interest has cost Verizon $3.2 billion in the past year, which reduces its bottom line. The company paid off $1.3 billion in the second and third quarters, but there's still a long way to go.
Fortunately, the debt load shouldn't cause any unexpected shocks to investors. Verizon's leverage is 3.2 times EBITDA, which is a bit higher than I would like (I look for leverage below 3 times EBITDA). However, this should not threaten the dividend as the payout ratio is quite high.
This will probably keep Verizon from being bold with the balance sheet, which could be good for investors hoping that Verizon remains focused on telecom. Keep paying down debt, let the interest savings go to profits, and maybe in time Wall Street will reward the stock with a higher valuation.
No one can know what the market will do next, but the fundamentals of the stock dictate where its price will eventually head. Verizon is unlikely to ever be a growth company, but it is a well-funded company with a high dividend. The stock's low valuation gives investors some cushion for the overall yield that may emerge when the company continues to improve its balance sheet.
Until then, a dividend yield of 6.6% is a good consolation prize for owning the stock, which is probably why most investors want to own the company's stock in the first place. If Verizon can deliver the 4% earnings growth expected by analysts, investors could get almost 10% of the annual return without even having to worry about whether the stock's valuation will recover. That sounds like a pretty good deal in this turbulent market.
As long as the price is above 36.50, follow the recommendations below::
- Time frame: D1
- Recommendation: long position
- Entry point: 39.98
- Take Profit 1: 43.00
- Take Profit 2: 46.50
Alternative scenario:
If the level of 36.50 is broken-down, follow the recommendations below:
- Time frame: D1
- Recommendation:short position
- Entry point: 36.50
- Take Profit 1: 34.50
- Take Profit 2: 32.00
