Retirees love dividend stocks. And there's no better place to look for dividend stocks than telecoms. What these industries lack in growth opportunities they more than make up for in quarterly cash payments to shareholders.
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But how can we tell when a telecom stock -- or its dividend -- is good buy? Today, we'll be comparing telecom giant AT&T (NYSE: T) with much smaller rival CenturyLink (NYSE: CTL). We're all probably familiar with the former and not so much the latter. But CenturyLink also sports an 8.8% dividend yield. Does that make it a better buy? Let's investigate.
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Sustainable competitive advantages
When Elon Musk moves on to his next big project and invents a time machine, I'm going to hop on board. I want to talk to my younger investing self. Here's my message: "Spend most of your time investigating sustainable competitive advantages."
Often called a "moat," there's no variable that's played a bigger role in determining my investing winners and losers than the underlying company's sustainable competitive advantages. In the telecom industry, the major advantage that players benefit from are high barriers to entry. It costs a fortune to build out the infrastructure -- towers, satellites, lines -- and all of those costs need to be paid up front -- before they ever have customers.
But since we already have to established telecoms battling it out here, that advantage falls by the wayside. Instead, I think there are two big factors at play. The first is simply market share. CenturyLink focuses primarily on providing Internet services to customers and businesses. It intensified that focus by agreeing to acquire Level 3 Communications (NYSE: LVLT) last year. At a Tier One provider, Level 3 provides access that other Internet providers then sell to business and residential customers. The combination of the two companies will allow CenturyLink to be one of the largest providers of internet services in the country.
AT&T, on the other hand, while it focuses on internet as well, is becoming much more of a content and media conglomerate. It owns about one-third of the U.S. wireless subscription market, according to Statista. And its acquisitions of DIRECTV and the announced plan to buy Time Warner mean that the company is expanding rapidly.
Essentially, CenturyLink is choosing to focus on becoming an internet provider. AT&T is focusing on becoming a communications company that owns content. Both have very strong positions in the market.
Winner = Tie
Obviously, telecom investors would like to see most of the money a company has returned in the form of dividends. But that's not always possible -- or advisable. Tough economic times hit, and when they do, it's important to have cash on hand. Given the debt-heavy nature of telecoms, this is especially important.
Here's how AT&T and CenturyLink stack up in terms of financial fortitude. And remember, AT&T is valued at roughly 18 times the size of CenturyLink.
Data source: SEC filings. Cash includes cash, short, and long-term investments.
While the difference between these two can be explained, in part, by their relative size difference, it's clear to me that AT&T is in a stronger position. I'm particularly worried about the fact that CenturyLink has such a low cash balance.
Part of this has to do with the acquisition on Level 3. That should help the company in the long run, but it introduces short-term fragility.
Winner = AT&T
Finally, we have valuation. While this isn't an exact science, there are some straightforward metrics we can consult to give us an idea of how expensive each stock is.
Data source: Securities and Exchange Commission filings, E*Trade. P/E represents figures from non-GAAP earnings.
This is where things get interesting. On virtually every metric, CenturyLink appears to be the better buy. Even the company's outsized 8.8% dividend yield looks safe, relative to the amount of free cash flow it eats up.
While the success of CenturyLink's strategy -- and its dividend sustainability -- will be closely tied to the success of the Level 3 acquisition, it seems like the cheaper stock to buy today.
Winner = CenturyLink
The winner is...
So there you have it: We have a draw. We've got two telecom players that are taking distinctively different approaches to the changing world of communications. AT&T is the giant that is in better financial shape, while CenturyLink offers a compelling valuation and dividend yield. At the end of the day, I'd recommend AT&T for the more risk-averse investor, while CenturyLink could provide superior returns if you have the stomach to handle the inherent risks involved.
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