Better Buy: AT&T vs. Verizon

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The telecommunications industry can be fertile ground for dividend investors. With their steady, recurring revenue streams and reliable cash flows, industry leaders like AT&T (NYSE: T) and Verizon Communications (NYSE: VZ) are able to reward their shareholders with hefty cash payouts -- especially with their stocks currently yielding 7.1% and 4.4%, respectively.

But which of these telecom titans is the better buy? Let's find out.

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Competitive strategy

Despite their media forays, Verizon and AT&T's wireless operations remain the core of their enterprises. And in this vital area Verizon has a powerful competitive advantage: It consistently ranks higher than AT&T in terms of network quality. That's helped Verizon gain valuable postpaid smartphone customers at a significantly faster clip than AT&T in recent quarters.

In response, AT&T has turned to expensive acquisitions to diversify its operations. It acquired satellite TV provider DIRECTV for $48.5 billion in 2015 as a means to strengthen its video offerings. But stiff competition from internet-based video services such as YouTube TV and Hulu Live are taking a toll on AT&T's TV businesses, and it now appears that it may have overpaid for DIRECTV.

That's worrisome, especially since AT&T just recently completed another megamerger. In June, the company closed its $85 billion acquisition of entertainment giant Time Warner. If AT&T fails to achieve the cost and revenue synergies it expects from the deal, shareholders could suffer further value destruction in the years ahead.

All told, Verizon's superior network and clearer focus on its wireless operations give it a competitive edge over AT&T -- and also make it a relatively lower-risk investment compared to its acquisition-focused rival.

Advantage: Verizon

Financial fortitude

Investors typically turn to the telecommunications sector for defensive, income-generating stocks. A telecom's financial strength, therefore, is paramount. Let's see how AT&T and Verizon measure up here.

Metric

AT&T

Verizon

Revenue

$164.44 billion

$130.54 billion

EBITDA

$51.37 billion

$47.65 billion

Operating income

$25.11 billion

$28.87 billion

Operating cash flow

$42.20 billion

$35.07 million

Free cash flow

$20.61 billion

$15.66 billion

Cash

$8.70 billion

$2.54 billion

Debt

$185.12 billion

$114.26 billion

AT&T has an advantage over Verizon in some important areas such as revenue, EBITDA, and free cash flow. But it also leads in an area it likely would rather not: debt. After its acquisitions of DIRECTV and Time Warner, AT&T's net debt now checks in at a whopping $176 billion, compared to a sizable, though far lower, $112 billion for Verizon. So with $64 billion less net debt on its balance sheet, Verizon gets the edge here.

Advantage: Verizon

Valuation

Lastly, let's take a look at some stock valuation metrics, including price-to-free cash flow (P/FCF), enterprise value-to-EBITDA (EV/EBITDA), and price-to-earnings (P/E) ratios.

Metric

AT&T

Verizon

P/FCF

9.99

14.49

EV/EBITDA

7.52

7.15

Forward P/E ratio

7.91

11.64

Verizon's stock is a bit less expensive when we account for AT&T's higher debt load, as is apparent when we compare their enterprise value-to-EBITDA ratios. Still, AT&T's shares are currently about 31% cheaper than Verizon's based on the free cash flow these businesses generated in the past year, and 32% cheaper based on analysts' earnings estimates for the year ahead.

Ultimately, it's earnings and free cash flow that will allow these companies to continue to pay out dividends to their investors. So with AT&T's stock more attractively priced in this regard, it gets the edge here.

Advantage: AT&T

The better buy is...

AT&T's stock may be cheaper, but Verizon's more focused competitive strategy and less debt-laden balance sheet make it the better buy today.

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Joe Tenebruso has no position in any of the stocks mentioned. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.