- Verizon Communications is the featured stock in November’s Safest Dividend Yields Model Portfolio.
- Companies with strong free cash flow provide higher quality and safer dividend yields because we know they have the cash to support the dividend.
- This Model Portfolio only includes stocks that earn an Attractive or Very Attractive rating, have positive free cash flow and economic earnings and offer a dividend yield >3%.
- Looking for a portfolio of ideas like this one? Members of Value Investing 2.0 get exclusive access to our model portfolio. Get started today »
Featured Stock for November: Verizon Communications
Verizon Communications (VZ) is the featured stock in November’s Safest Dividend Yields Model Portfolio. We made VZ a Long Idea in September 2019 and the stock remains undervalued.
In 2018, VZ grew revenue by 4% year-over-year and after-tax operating profit (NOPAT) by 22% YoY, per Figure 1. Trailing twelve month (TTM) NOPAT is up 12% over the prior TTM period. Longer term, VZ has grown NOPAT by 4% compounded annually over the past decade. Profit growth is driven by VZ’s NOPAT margin rising from 15% in 2008 to 18% TTM.
Figure 1: VZ’s Revenue and NOPAT Growth Since 2017
Sources: New Constructs, LLC and company filings
VZ’s Free Cash Flow Supports Dividend Payments
Verizon has increased its annual dividend payment in each of the last 12 years. Since 2014, VZ has increased its annual dividend from $2.16/share to $2.42/share TTM, or 2% compounded annually. This dividend payment has been supported by VZ’s cumulative free cash flow. VZ’s free cash flow decline came to an end in 2018, after the firm promoted former CTO Hans Vestburg to CEO and halted its value-destroying acquisition strategy. Since then, FCF has improved significantly, per Figure 2. From 2014-2018, VZ generated $50.7 billion (21% of market cap) in FCF while paying $44.8 billion in dividends.
Figure 2: VZ’s FCF vs. Dividends Since 2014
Sources: New Constructs, LLC and company filings
Companies with strong free cash flow provide higher quality dividend yields because we know the firm has the cash to support its dividend. On the flip side, dividends from companies with low or negative free cash flow cannot be trusted as much because the company may not be able to sustain paying dividends.
VZ Remains Undervalued
At its current price of $59/share, VZ has a price-to-economic book value (PEBV) ratio of 0.6. This ratio means the market expects VZ’s NOPAT to permanently decline by 40%. This expectation seems too pessimistic given that VZ grew NOPAT by 22% YoY in 2018, 11% YoY in the TTM period, and 9% compounded annually over the past two decades.
If VZ can maintain TTM NOPAT margins (18%) and grow NOPAT by just 2% compounded annually for the next decade, the stock is worth $110/share today – an 86% upside. See the math behind this reverse DCF scenario.
Critical Details Found in Financial Filings by OurRobo-Analyst Technology
As investors focus more on fundamental research, research automation technology is needed to analyze all the critical financial details in financial filings as shown in the Harvard Business School and MIT Sloan paper "Core Earnings: New Data and Evidence.”
Below are specifics on the adjustments we make based on Robo-Analyst findings in Verizon Communication’s 2018 10-K:
Income Statement: We made $21.6 billion of adjustments with a net effect of removing $7.1 billion in non-operating expense (5% of revenue). See all adjustments made to VZ’s income statement here.
Balance Sheet: We made $172.9 billion of adjustments to calculate invested capital with a net increase of $83.3 billion. The most notable adjustment was $67.5 billion (30% of reported net assets) related to deferred taxes. See all adjustments to VZ’s balance sheet here.
Valuation: We made $190.6 billion of adjustments with a net effect of decreasing shareholder value by $189.8 billion. The largest adjustment to shareholder value was $137.2 billion in total debt, which includes $21.2 billion in operating leases. This lease adjustment represents 9% of VZ’s market value. See all adjustments to VZ’s valuation here.
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