Telecoms: Add a second dividend line

Verizon is a solid payer, and Vodafone even offers growth potential.

By InvestorPlace Mar 26, 2012 10:23AM

By Charles Sizemore

 

"It's hip to be square."
-- Huey Lewis and the News

 

It's a funny world we live in. Investments that would have been considered the domain of widows and orphans a decade ago are now downright trendy.

 

I'm talking, of course, about dividend-paying stocks. During the raging bull markets of the 1980s and 1990s and the housing boom of the 2000s, investors gave little thought to the income being thrown off by their investments. When you could flip a tech stock -- or a house -- in a couple of months and walk away with a 50% gain, earning a couple extra dollars from dividends seemed a little petty.

 

Two bear markets and a housing collapse later, investors have come to appreciate the certainty of getting a regular dividend check rather than waiting -- and hoping -- for the market price to rise. In a volatile, uncertain world, dividends might be the only return you get. This certainly was the case for investors who held S&P 500 index funds last year. Not including the 2% dividend, their return would have been exactly zero.

 

Now, some of the highest yields available are in the telecom sector. In prior articles, I've written at length about Spanish telecom giant Telefónica (TEF), which still is one of my favorite stocks to hold for the rest of this decade.

 

Today, I'm going to take a look at one of Telefónica's European rival, British-based Vodafone (VOD), and its American partner, Verizon Communications (VZ). The two companies jointly own Verizon Wireless, the largest mobile phone operator in the United States. (Verizon holds 55% of Verizon Wireless, and Vodafone the remaining 45%.)

 

I'll start first with Verizon because the investment case is more straightforward. You buy Verizon for the dividend stream; end of story.

 

Verizon currently pays out $2 per share in dividends, which works out to a yield of 5%. That's a great yield in a world where the 10-year Treasury barely yields 2%. Importantly, Verizon also has a long history of raising its dividend -- the $2 a share dividend that investors enjoy today was just $1.50 a share 10 years ago.

 

Investors should not, however, expect much in the way of capital gains. With the exception of the smartphone and tablet data plans sold by Verizon Wireless, all of the company's businesses are mature and in more or less saturated markets. The home landline business is in terminal decline, and home Internet and video services are no longer a growth industry. Growth in business telephony is dependent on growth in business employment, which has been a little less than stellar these days.

 

Furthermore, Verizon is an American company with very little exposure to faster-growing emerging markets.

 

Verizon also is far from cheap. It trades at 14 times estimated 2013 earnings.

 

For all of these reasons, Verizon investors should look at their stock the same way they would look at a corporate bond -- as a source of current income and nothing more.

 

Vodafone is a more intriguing investment opportunity. Although it yields slightly less in dividends than Verizon (3.6% vs. 5%), Vodafone is priced at only 10.3 times forward earnings.

 

Vodafone also happens to benefit from the areas of Verizon's business that still have growth potential -- those operated by Verizon Wireless. Verizon recently authorized Verizon Wireless to pay a dividend to Vodafone for the first time since 2005. The one-time dividend amounts to $4.3 billion, which is not particularly large for a company of Vodafone's size (Vodafone had $74 billion in sales last year). Still, $4.3 billion is nothing to sneeze at.

 

Vodafone suffers from the same problem Verizon does in its home market -- the United Kingdom and Europe are mature markets, and outside of smartphone data plans, opportunities for growth are slim.

 

My biggest reason for liking Vodafone is its exposure to emerging markets, a characteristic it shares with rival Telefónica. Vodafone has 134 million customers in India alone, and more than 75 million in Africa.

 

Mobile phones are clearly no longer a novelty anywhere in the world, but market penetration in most emerging markets is less than half that of Europe. And even within their existing customer base there is enormous potential. Prepaid customers can be converted to more profitable post-paid subscribers, and both can be upsold to higher-minute plans and data plans. There are years (if not decades) of high growth rates to be enjoyed in Vodafone's primary emerging markets.

 

How can I be so sure? Let's take a look at the numbers. Sixty-two percent of Vodafone's customers are in emerging markets, yet they only account for 27% of the company's revenues. This gap might never fully close, but you can rest assured it will get a lot closer as emerging markets continue to grow and thrive.

 

Vodafone also is a proud member of the International Dividend Achievers club -- meaning that the company has a long history of raising its annual dividend -- and a holding of the PowerShares International Dividend Achievers ETF (PID) that follows the International Dividend Achievers strategy.

 

Bottom line: For a high yield today, buy Verizon. For a longer-term growth story that also pays a respectable and growing dividend, choose Vodafone.

 

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter, and the chief investment officer of investments firm Sizemore Capital Management. TEF and PID are held by Sizemore Capital clients.

 

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