Top Telecom Stocks to Buy Now

By Markets Fool.com

Image source: Getty Images.

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In investing, we're often our own worst enemies. The temptation to seek out the extraordinary distracts from simply sticking to what's been proven to work -- buying great companies and sitting on our hands while the rewards accrue over time. Staying the course in many respects requires more discipline than leaping into action.

In the boring world of telecom investing, the best wireless stocks to buy now are also the most obvious. Thanks to their dominant competitive advantages, AT&T (NYSE: T) and Verizon Communications (NYSE: VZ) remain better telecom stocks than their smaller insurgent rivals T-Mobile(NASDAQ: TMUS) and Sprint(NYSE: S). See for yourself:

Company Name

Dividend Yield

No. Consecutive Annual Dividend Increases

AT&T

4.9%

31 years

Verizon Communications

4.5%

9 years

Sprint

N/A

N/A

T-Mobile

N/A

N/A

Data sources: Dividend.comand Google Finance.

This chart doesn't completely express why AT&T and Verizon trump T-Mobile and Sprint, so let's delve deeper into the dynamics driving the four-horse race playing out in the U.S. telecommunication market.

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A class apart

While the legacy status of "insider" and "outsider" doesn't itself account for the industry's current competitive balance, it is interesting to note that the two largest companies, AT&T and Verizon, trace their corporate roots back to the original AT&T wireline monopoly of yesteryear -- while both Sprint and T-Mobile formed as outsider challengers and in many ways remain outsiders today. Here's how the subscriber count stood between AT&T, Verizon, Sprint, and T-Mobile as of Q2 2016.

Carrier

Subscribers

Q2 2016 Net Subscriber Change

Average Revenue Per User (ARPU)

Verizon Wireless

142.7 million

1.28 million

$47.07

AT&T

131.8 million

1.36 million

$52.69

T-Mobile USA

67.3 million

1.88 million

$42.60

Sprint

58.4 million

(0.36 million)

$43.89

Data source: Fierce Telecom.

This massive difference in subscriber counts and revenue bases gives Verizon and AT&T a meaningful advantage in the notoriously capital-intensive telecom business. In terms of capturing this difference, the following chart most effectively expresses the stark difference between AT&T and Verizon at the upper echelon and T-Mobile and Sprint at the lower end of the market.

Metric

AT&T

Verizon

Sprint*

T-Mobile

Cash flow from operations

$35.8 billion

$38.9 billion

$9.0 billion

$5.4 billion

Capital expenditures

$19.2 billion

$17.7 billion

$7.0 billion

$4.7 billion

Free cash flow from operations

$16.6 billion

$21.2 billion

$2.0 billion

$700 million

Data source: BofA Merrill Lynch. FY 2015 data. *Denotes 12 months ending 3/31/16.

There are a few things to note here. First, this isn't the strict accounting definition of free cash flow. Rather, the above chart's bottom row measures the amount of cash each telecommunications company has left over after it meets its capital investment needs. Though Sprint and T-Mobile are indeed profitable on this basis, the amount of cash flow that remains after investment requirements pales in comparison with AT&T and Verizon.

The after-capex cash flow gives Verizon and AT&T a tremendous competitive advantage relative to their smaller competitors. It enables Verizon and AT&T to more comfortably invest in long-term growth initiatives, engage in mergers and acquisitions, fund and grow their dividends, and more. This difference may become a more acute advantage in the coming years as the U.S. telecom market begins to shift toward the still-distant 5G network standards. Case in point: One telecom industry consulting group estimates that investment in 5G networks will require $104 billion in capital expenditures through 2025. When the time comes to foot that bill, which wireless companies do you think will be able to more comfortably and quickly shell out the needed money?

To be sure, Sprint and T-Mobile have both made impressive strides over the past five years. However, even despite meaningful improvements to their networks, the cold reality is that they remain significantly behind AT&T and Verizon in most measurable statistics. As such, AT&T and Verizon stand as my picks for the telecom stocks to buy today.

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Andrew Tonner has no position in any stocks mentioned. The Motley Fool recommends T-Mobile US and 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.