Better Buy: AT&T Inc. vs. Verizon Communications

By Markets

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Investors interested in stable growth and dividend income have likely seen both AT&T (NYSE: T) and Verizon Communications (NYSE: VZ) fly across their radars. Both telecom giants have relatively high dividend yields compared to the market average, and their monthly subscription revenue provides the cash needed to keep everything running smoothly.

Both are facing competitive pressures in the wireless industry, and each is investing heavily to diversify its businesses. Trying to decide between these two heavyweights can be a difficult decision, so let's take a closer look at how they compare.

Who has a better dividend?

The strength of a dividend isn't all about its current yield. Investors have to factor in how safe the dividend is for the company to continue paying, and how likely management is to increase the dividend -- and by how much.

AT&T's dividend currently yields 4.65%, slightly better than Verizon's 4.39% yield. Additionally, AT&T's management has shown a strong commitment to raising its dividend every year, with 32 years of consecutive annual dividend increases. Verizon, meanwhile, has only increased its dividend 10 consecutive years.

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But where AT&T's dividend payments are expected to amount to about 67% of its earnings this year, Verizon only pays out 60% of its earnings as a dividend. Both ratios are well within a safe range of earnings, but Verizon's lower payout ratio indicates that it has more room to increase its dividend.

Verizon has a similar advantage when looking at free cash flow. Verizon produced $3.77 per share in free cash flow over the trailing 12 months, and its annual dividend rate of $2.31 per share represents 61% of that amount. Comparatively, AT&T generated $2.72 in free cash flow per share, and it's paying out $1.92 per share in dividends -- 71%.

Neither company is increasing their dividend significantly right now. Verizon's recent dividend increase announced at the beginning of September was just 2.2%. AT&T, meanwhile, has increased its quarterly dividend just $0.01 each year since 2009.

Both are stockpiling cash for acquisitions and wireless spectrumand could start growing their dividends at a more aggressive pace again in 2018. When that happens, Verizon should continue to grow its dividend faster, which makes it much more appealing than AT&T.

A look at valuation

Another equally important factor for investors to consider when deciding between AT&T and Verizon is their relative valuations. AT&T stock currently trades for 17.7 times its trailing 12-month earnings. Comparatively, Verizon stock trades for just 14.7 times its trailing earnings.

But one reason AT&T stock is trading for a significantly higher multiple is because analysts expect earnings to grow moderately this year with the addition of DIRECTV. Shares are trading for just 14.4 times AT&T's 2016 earnings expectations.

Verizon, on the other hand, is expected to see its earnings decline this year after selling some of its wireline assets to Frontier Communications. Analysts currently expect earnings to decline 2.5% to $3.89 per share. Still, shares are only trading at 13.4 times its forward earnings.

Again, Verizon has the advantage on a free cash flow basis as well. AT&T's price-to-free-cash-flow ratio of 15.1 is notably higher than Verizon's 13.8 ratio.

AT&T may have somewhat better earnings growth prospects with the addition of DIRECTVand its expansion in Mexico, but Verizon's strength in its core wireless business and its expansion into digital advertising offer a lot of upside as well.

With better dividend growth prospects and a lower valuation, Verizon is a better buy than AT&T right now.

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Adam Levy owns shares of Verizon Communications. The Motley Fool recommends Verizon Communications. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.