Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / Why Verizon Dividends Outperform in a Steepening Curve
Transcript
- Lucas: Alright Luna, let's talk about a stock that a lot of income investors have written off as boring or worse, in decline. I'm looking at Verizon, ticker V-Z, and its roughly six point two percent dividend yield. Luna: That is a big yield in this environment. Especially when the ten-year Treasury is yielding four point six percent. And the curve is steepening. Lucas: Right. On July 20th, the ten-year touched four point six percent, up from four point five five a week earlier. The two-year also rose to four point two one. So the spread between them widened to thirty-nine basis points from thirty-seven. That is a meaningful move. Luna: And the common wisdom is that when bond yields go up, dividend stocks lose their appeal. Why should I take the equity risk for a yield that's only one hundred eighty basis points more than a risk-free government bond? Lucas: That's the right question. And normally, I'd agree. But Verizon's case is different because of what's happening in the telecom industry. The big capital expenditure cycle for five-G is peaking. That has been a drag on free cash flow for years. But as that spending winds down, free cash flow should improve. Luna: So the payout ratio has been artificially high because of heavy capex? And it's about to drop? Lucas: Exactly. Verizon's dividend payout ratio on an earnings basis is about fifty-one percent for the last twelve months. That is safe. But on a free cash flow basis, it's been over seventy percent, sometimes higher. That has spooked yield investors. But analysts expect free cash flow to increase about fifteen percent next year as capex declines. Luna: That would bring the free cash flow payout ratio down to maybe sixty percent. That is much more comfortable. Lucas: Exactly. And the dividend itself grew about two percent in the last year. Not fast, but steady. The company has increased its dividend for eighteen consecutive years. It's not an aristocrat yet, but it's getting there. Luna: And the stock price has been under pressure. It's down about twelve percent from its high in 2021. So the yield has climbed. And with rates where they are, there's an argument that the sell-off is overdone. Lucas: That's where the steepening curve comes in. The market is pricing in that the Fed is done hiking. The effective federal funds rate is flat at three point six three percent. So long-term rates are rising because of term premium and inflation expectations, not because of tightening. That environment is actually good for a stock like Verizon. Luna: Because its revenue is tied to long-term contracts and subscribers. It's not cyclical. And its debt is largely fixed-rate, so rising yields don't hurt its interest costs much. Lucas: Right. Verizon has about one hundred fifty billion dollars in debt, but over ninety percent is fixed rate with an average maturity of about twelve years. So the higher yields on new debt only affect a small portion of refinancing. The real risk is if the economy slows and subscribers cut back, but that's not happening right now. Luna: So what does the steepening curve mean for the stock price specifically? Does it make the dividend more or less attractive versus bonds? Lucas: I think it makes the stock more attractive, because the spread between the dividend yield and the ten-year is still about one hundred sixty basis points. Historically, when that spread has been this wide, Verizon stock has tended to outperform over the next twelve months. The last time the spread was above one hundred fifty basis points was in late 2022, and the stock returned about twenty percent over the following year. Luna: That's a good data point. But I also want to bring in what's happening with other dividend stocks. Realty Income, ticker O, is up about two point seven percent in the last five days. Its yield is about five point four percent. That is also attractive versus bonds. Lucas: Realty Income is a different case because it's a REIT. Its yield is above Verizon, but its dividend growth is slower, and it's more sensitive to interest rates because of its floating-rate debt and property valuations. The steepening curve could actually hurt REITs if long rates keep rising. But Verizon is less sensitive. Luna: So for a pure income play, you prefer Verizon over Realty Income right now? Lucas: For this moment, yes. But keep in mind, I'm not saying buy or sell. I'm saying the risk-reward for Verizon looks better than the bond market implies. The dividend is safe, the payout ratio is improving, and the stock is cheap on an earnings basis with a price to earnings ratio of about ten. Luna: That is a single-digit P/E. In this market, that's rare. Even the S&P 500 is trading at about twenty-two times earnings. Lucas: Right. The S&P 500 is down about point eight percent in the last five days, but it's still near all-time highs. Verizon is down twenty percent from its peak. There is a value argument here, but it's not without risks. The biggest risk is that the capex cycle doesn't wind down as expected, or that competition from T-Mobile and AT&T forces Verizon to keep spending. Luna: And there's also the risk that the economy tips into recession and subscriber churn increases. But that's a general market risk. Lucas: Exactly. So the bottom line is: if you're an income investor looking for a yield that's significantly above Treasuries, with a safe payout ratio and a catalyst for free cash flow improvement, Verizon is worth a look. Just don't expect rapid dividend growth. It's a steady payer, not a growth story. Luna: And that's actually why a lot of our listeners appreciate the show. We try to cut through the noise and focus on the numbers that matter for building a reliable income stream. Lucas: Yeah, and one thing that keeps this show going without ads or sponsors is listener support. If you find these breakdowns helpful, you can support the show at buy me a coffee dot com slash fexingo. That's buy me a coffee dot com slash fexingo. It helps us keep the episodes focused on what matters. Luna: And it really does make a difference. We don't have a big production team, just the two of us and the research. So every bit of support helps us keep this ad-free and honest. Lucas: Alright. Back to the steepening curve. One more angle I want to touch on is how this affects dividend ETFs like VYM and SCHD. VYM is up about point two percent in the last five days, while SCHD is up one point five percent. Both are holding up better than the S&P 500. Luna: That makes sense because they are overweight value and income stocks. VYM has a big position in Verizon, actually. It's one of its top holdings. Lucas: Right, VYM holds about two point five percent in Verizon. So the ETF gets a boost from the yield and the relative stability. SCHD is more focused on dividend growth, so it has less exposure to telecom and more to industrials and healthcare. That's why it's up more this week. Luna: So for a listener who wants a diversified income portfolio but also wants to bet on the steepening curve, would you recommend an ETF like VYM or a specific stock like Verizon? Lucas: I think it depends on their risk tolerance. An ETF gives you diversification across forty or fifty stocks, so you're not as exposed to company-specific risks. But if you have a high conviction about the telecom sector and the capex story, Verizon offers a higher yield and more upside potential. Just be prepared for volatility. The stock has a beta of about point five, so it's less volatile than the market, but it can still drop ten to fifteen percent in a bad quarter. Luna: And speaking of bad quarters, we should mention that Verizon reports earnings next week. That could be a catalyst, positive or negative. Lucas: Good point. If they announce that capex is coming in lower than expected, or that subscriber growth is strong, the stock could pop. But if they cut guidance, the yield could become a trap. That's the risk with any high-yield stock. Luna: So the key is to watch the free cash flow number. Not just earnings per share. Lucas: Exactly. The dividend is paid from cash flow, not accounting earnings. So the free cash flow trajectory is what matters most for dividend safety. Luna: Alright, Lucas. I think we gave our listeners a solid framework for evaluating Verizon in this rate environment. Anything else to add? Lucas: Just that the steepening curve is a signal that the bond market expects higher growth or higher inflation. For dividend investors, that means favoring companies with pricing power and stable cash flows. Telecom fits that bill. But always do your own analysis. Luna: Good advice. Thanks Lucas. Lucas: Thanks Luna. Until next time.