AT&T (T) is one of the largest telecom companies in the United States when measured by market cap ($225 billion). Its only competitor of similar size is Verizon Communications ($241 billion), notes Ben Reynolds, who reviews both stocks in his The Sure Retirement Newsletter.

In late October, AT&T reported (10/24/18) financial results for the third-quarter of fiscal 2018. Results were not appreciated by the market. Still, the company’s fundamentals appeared strong. Revenue rose 15%, largely due to the contribution of Time Warner (which was acquired by AT&T on June 14th) and partially offset by weakness in the Latin American and Entertainment Group segments.

Further down the income statement, adjusted operating margins rose 310 basis points to 21.9% in the third-quarter, which represents a tremendous improvement over last year’s comparable quarter.

On the bottom line, AT&T’s adjusted earnings-per-share rose 22% to $0.90 while the company’s free cash flow of $6.5 billion increased by 16% over the same period a year ago. Overall, we were happy with AT&T’s earnings release despite the market’s pessimistic reaction following the announcement.

AT&T has recently executed two sizeable acquisitions — DirecTV and Time Warner — in an attempt to improve its growth profile. Indeed, the company’s 10-year growth rate of 3.9% leaves much to be desired. We believe that these new higher-margin businesses will allow AT&T to grow at a faster pace moving forward.

We are anticipating earnings-per-share growth of about 6% per year for AT&T. AT&T scores extraordinarily well in terms of dividend safety. The company has increased its dividend for 33 consecutive years, which qualifies it to be a member of the Dividend Aristocrats Index. Separately, AT&T is on pace for a dividend payout ratio of just 57% this year.

While some investors have expressed concerns with AT&T’s debt, it reported a more-than-adequate interest coverage ratio of 3.4x through the first nine months of fiscal 2018 (composed of $19.9 billion of operating income and $5.8 billion of interest expense). AT&T plans to deleverage over the next several years as well.

AT&T’s executive management team expects the company to generate adjusted earnings-per-share of about $3.50 in fiscal 2018. Using this earnings estimate, the company is trading at a price-to-earnings ratio of just 8.8.

For context, AT&T traded at an average price-to-earnings ratio of 13.4 over the last decade. If AT&T’s price-to-earnings ratio can expand to its 10-year average over the next 5 years, this will boost its total returns by around 8.8% per year during this time period.

Overall, we believe that AT&T is capable of delivering annualized returns of more than 20% per year from its current price thanks to its high yield (6.6%), earnings growth (6%), and potential for valuation expansion.

Verizon is the largest wireless carrier in the country. Its wireless segment contributes approximately three-quarters of its aggregate revenue and covers approximately 298 million people and 98% of the United States.

In late October, Verizon reported (10/23/18) financial results for the third-quarter of fiscal 2018. In the quarter, revenue grew 2.8% to $32.6 billion, which beat analyst estimates by $110 million. Earnings-per-share of $1.22 beat estimates by $0.03 and grew by more than 24% over the same period a year ago.

Verizon has grown its earnings-per-share at a rate of approximately 5% per year over the last decade. We believe that this rate of growth is sustainable for Verizon over full economic cycles. Future growth will be driven by the continued strength of its wireless segment as well as new initiatives such as the introduction of 5G networking.

Verizon scores very well on all of our important measures of dividend safety. The company is on pace for a payout ratio of just 54% in fiscal 2018. Moreover, the company has increased its dividend for 11 consecutive years and is likely to continue to pay rising dividends for the foreseeable future.

Lastly, Verizon consistently operates with an interest coverage ratio exceeding 5x and is on pace for approximately 5.5x of interest coverage in fiscal 2018. The company’s combination of safety and yield makes it compelling for yield-hungry investors with low risk tolerances.

Verizon is likely to generate earnings-per-share of approximately $4.35 in fiscal 2018. Using this estimate, the company is trading at a price-to-earnings ratio of 13.4 today.

Verizon traded at an average price-to-earnings ratio of 14 over the last decade. If the company’s price-to-earnings ratio can expand to its 10-year average over the next 5 years, this will increase Verizon’s total returns by about 0.9% per year.

Through a combination of dividend payments (4.1%), earnings growth (5%), and valuation expansion, Verizon appears priced to deliver total returns of approximately 10% per year moving forward.

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