Why the market is wrong on Verizon

Investors aren't thinking clearly, shunning Verizon in favor of fad investments like REITs that are sure to shrivel up

By InvestorPlace Apr 20, 2010 6:58AM

By Richard Band, editor of Profitable Investing

 

verizon money trapWhy do investors keep repeating self-destructive (money-losing) behavior?  You can see the syndrome at work in the recent explosive rally among the real estate trusts.


Since Feb. 9, the Morgan Stanley U.S. REIT Index (RMZ) is up about 25%. The same index has skyrocketed over 150% from its March 2009 low -- about double the gains for the broader market.

 

As a result, dividend yields in the sector have collapsed... And low-risk dividend investors somehow are getting duped into thinking REITs are solvent investments. Many of them aren't. Meanwhile, the Street still loves to hate telecom leaders Verizon (VZ) and AT&T (T) despite low P/E ratios and hefty dividend yields.

So what's going on? What the heck is the market missing?

Take Simon Property Group (SPG)a mall owner and the largest REIT by market capitalization. It's now priced to deliver a yield of only 3% on cash flow. That's totally insane for a company in a slow-growing (and highly cyclical) business.


I don't know what triggers this investor masochism, but I have a theory. The Internet has opened up a wonderful cornucopia of information, much of it free or nearly free.

Normally, when faced with a deluge of information, people slow down, turn cautious and try to sort out the conflicting points of view before acting. With the advent of the Internet, though, it seems that a certain class of investor (the thrill seeker) feels more empowered than ever.


Overconfidence drives this person to jump on trends and ride them, without much forethought. And so, certain markets and sectors can take on a life of their own, soaring to heights and plunging to depths that no rational person would have imagined possible.


While the thrill seekers are piling into REITs (and shaggy-dog banks), slurping up every last drop of risk they can find, conservative investors are scared to death of big telecoms like Verizon. Relative to the S&P 500, VZ is trading near an 18-month low. In the past year alone, the stock has lagged the S&P by a stunning 4800 basis points.


What's everybody afraid of? That VZ might, just might, have to cut its dividend.

Now, I'm not exactly thrilled myself that Verizon is paying out 81% of its estimated 2010 earnings in the form of dividends. However, I also recognize that the telecom giant generates enough free cash flow (thanks to huge depreciation write-offs) to cover the dividend twice over. Absent a double-dip recession, there's almost no risk of a dividend cut in 2010; and the likelihood in 2011 is even smaller.

What's more, if VZ and Vodafone (VOD) can reach a sensible deal to transfer the full ownership of their Verizon Wireless joint venture to Verizon, I would expect the market to assign a significantly higher P/E to Verizon shares. (We're talking a capital gain of maybe 15%-20% here.)


So don't pay attention to the market's "flavor of the month." Buy VZ right now. It's current yield of 6.4% is higher than the yield on Verizon's own 30-year bonds, so this dividend is here to stay. Share prices, on the other hand, aren't -- so don't delay.

 

Disclosure: Richard Band owned shares of VZ in personal or client portfolios at the time of this writing.

 

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