Verizon (NYSE: VZ) has long been a favorite stock among income-focused investors. And with its dividend yield currently checking in at a solid 4%, the leading U.S wireless carrier remains a popular income-generating investment.
Yet every business has risks, and it's important to study the threats that could derail your investments. That way, you won't be blindsided by them, and you can identify the key trends you should be watching.
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In this regard, here are three risks Verizon investors will want to be aware of.
1. Intensifying competition
The U.S. wireless industry is a fiercely contested arena. And one of Verizon's most troublesome rivals, T-Mobile (NASDAQ: TMUS), is gaining subscribers at a rapid clip. The No. 3 U.S. wireless carrier added 774,000 postpaid phone subscribers in the third quarter. Such subscribers pay monthly bills and are typically the most sought-after customers for wireless carriers. This marked the 19th consecutive quarter that T-Mobile led the industry in this important metric. Verizon, meanwhile, added only 295,000 net phone subscribers during this period.
T-Mobile's unconventional moves -- such as eliminating contracts and overages and including a free Netflix subscription with its family plans -- are helping to chip away at Verizon's lead. T-Mobile is also spending heavily to strengthen its network, so much so that its network quality is now considered to be on par with that of Verizon's.
Going forward, it will be more difficult for Verizon to claim that its network is superior. And with this core aspect of its competitive strategy now weakened, it finds itself with a difficult choice: continue to lose customers to T-Mobile, or attempt to match its rival's aggressive promotions. Neither one of those options is ideal, and both could crimp Verizon's profits in the coming years.
2. Costs are set to rise
Verizon's recurring revenue streams and stable cash flows allow it to finance its business with large amounts of debt. Yet this debt has ballooned to staggering proportions in recent years. The company now has nearly $113 billion in debt versus only $2.5 billion in cash. In turn, Verizon paid out more than $1.2 billion in interest in the third quarter alone.
And now, with rates set to rise as the Federal Reserve moves to normalize its interest rate policy, Verizon's debt service costs could increase dramatically in the coming years. Making these payments will likely not be an issue -- Verizon produced nearly $7.7 billion in operating income in the third quarter, which covered its interest payments several times over. But higher interest costs could weigh on profits and, by extension, make dividend increases more difficult.
Verizon's leadership already appears to be taking this into account. The company recently raised its dividend for the 12th consecutive year. Yet this year's increase is only 2.1%, which is below the current rate of inflation in the U.S. Thus, investors who count on Verizon's dividend to fund their expenses may see their purchasing power decline slightly in the years ahead. Should this continue, income investors could sour on Verizon's stock.
3. Rising interest rates can make Verizon's dividend less attractive
Dividend stocks have historically been fertile ground for yield-hungry income investors, particularly in low-rate environments. But if the Federal Reserve continues to raise rates, bonds and other fixed-income investments will become more attractive as their yields rise.
In such a scenario, dividend-paying stocks could become relatively less appealing, as they are generally seen to be higher-risk investments than bonds. Thus, if interest rates continue their ascent, investor demand for Verizon's stock could be reduced, causing its price to fall.
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Joe Tenebruso has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Netflix. The Motley Fool recommends T-Mobile US and Verizon Communications. The Motley Fool has a disclosure policy.