The US stock market has returned somewhere around 10% annually when averaged out over the last several decades.
Using the Rule of 72, those who have captured this performance have doubled their money roughly every seven years.
Great, right?
Well, yes, but there’s a small problem with this.
If most of the performance is through capital gain, one would have to sell off shares in order to produce income.
That’s akin to “killing the golden geese”.
Wouldn’t you rather just live off of an ever-larger pile of golden eggs, which avoids the risk of running out geese to kill?
Converting stock market gains into income that can be used to pay real-life bills is a nice problem to have.
But it is a problem, nonetheless.
This is where dividends come in.
And not just dividends but large dividends.
Dividends large enough to cover bills without having to sell off shares.
And if these large dividends also grow over time, in order to keep pace with (or outpace) inflation, all the better.
Well, that’s what this series, where we do a deep dive on a high-yield dividend growth stock once per month, is all about.
We’re covering some of the very best high-yield ideas in the entire stock market.
By the way, these aren’t high-yield junk stocks where you have to worry about whether or not your dividends are sustainable.
These very real cash dividends are supported by very real business revenues and profits.
Plus, these are growing dividends.
That’s right.
In a reality where inflation is slowly causing the prices of everything to rise, eating away at one’s purchasing power in the process, we have to make sure that our income can also rise over time and keep up with increasing costs.
After all, a high yield becomes decreasingly effective over time if it’s slowly getting chipped away at by inflation.
With all of that in mind, I want to cover a high-yield dividend growth stock that can help you to cover your bills and make your life a lot easier…
Verizon Communications Inc. (VZ)
Verizon Communications Inc. (VZ) is an American multinational telecommunications conglomerate.
Founded in 1983, Verizon now has a $151 billion market cap.
The company reports results across two business units: Verizon Consumer, 76% of FY 2022 revenue; and Verizon Business, 23%. Corporate and Other accounts for the remainder.
As of December 31, 2022, Consumer had approximately 114.5 million wireless retail connections, 7.9 million broadband connections, and 3.2 million Fios video connections.
As of December 31, 2022, Verizon had approximately 115 million wireless retail connections (of which 80% are postpaid), approximately 8 million total broadband connections, and approximately 3 million Fios video connections.
Verizon was originally a phone company that provided fixed-line telecom services.
Nowadays, it’s so much more than that.
As one of the leading wireless carriers in the US, Verizon is benefiting from the explosion in demand for mobile data.
And with the 5G rollout now in full swing, this demand is likely only going to rise.
That’s because mobile data is moving from simplistic use cases like phones to more complex use cases like IoT.
Indeed, we’re already living in a society in which everything from home appliances to vehicles are interconnected in real-time, and all of this digital communication requires high-speed access to the internet.
That’s exactly where Verizon comes in, as the company is in the business of providing the “digital pipes” to/from the internet.
Verizon does this mostly through mobile connections (such as on a smartphone).
However, it’s increasingly doing this through fixed wireless (FWA), which is wireless technology that can be used to connect homes and businesses to the internet by enabling fixed broadband access that uses radio frequencies instead of cables.
It’s almost impossible to imagine a future in which there’s less demand for access to the internet, which should put a floor under this business and what it offers.
Meantime, the stock’s massive dividend can put a floor under one’s passive income.
Dividend Yield And Growth
I say that because this stock yields 7.5%.
That’s about five times higher than the broader market’s yield.
It’s also 240 basis points higher than its own five-year average yield.
You are just not going to find this kind of yield very often, and certainly not in a package that offers some growth and safety.
To that point, Verizon has increased its dividend for 19 consecutive years.
What this means is, not only are you getting a sky-high payout but one that’s also increasing.
Now, the 10-year dividend growth rate is only 2.5%.
But it’s better than nothing.
And it’s actually in line with normal inflation, which keeps your purchasing power intact under ordinary circumstances.
With the payout ratio sitting at 56.6%, based on midpoint guidance for this year’s adjusted EPS, this is one of the most reliable large dividends out there.
This is important.
Bills are very reliable.
They just keep coming.
And when dividends are being used to pay the bills, the dividends need to be just as reliable as the bills.
For investors looking for a very high yield in this market, this is one of the best out there.
Revenue and Earnings Growth
Verizon is able to afford that big, growing dividend because the business is putting up big, growing revenue and profit.
Yes, Verizon has grown its revenue from $120.6 billion in FY 2013 to $136.8 billion in FY 2022.
That’s a compound annual growth rate of 1.4%.
Far from amazing growth, but Verizon is working with a huge sales base here.
That sales base is so huge because there are so many customers signed up with Verizon and paying their bills, allowing shareholders to pay their bills from the big dividends they collect from Verizon.
Verizon increased its earnings per share from $4.00 to $5.06 over this 10-year period, which is a CAGR of 2.7%.
We can now see how well bottom-line and dividend growth line up.
Almost exactly the same.
Again, the growth isn’t impressive, but this is an income play (not a compounder).
And Verizon really does get the income job done with that big dividend supported by big revenue and earnings.
In my view, low-single-digit growth like this is more than acceptable when the yield is already so high.
It’s certainly better than a lot of income plays elsewhere in the market where the dividends are unreliable and/or frequently getting cut.
Importantly, Verizon recently raised its free cash flow guidance for FY 2023 from $17 billion to $18 billion.
That’s more free cash flow to cover that juicy dividend.
The dividend costs Verizon approximately $11.7 billion per year in total, so we can see clear skies ahead for this high yield.
What we have here is a large, mature business gushing billions of dollars per year in free cash flow and returning most of it back to shareholders in the form of a massive dividend.
It’s basically the definition of a cash cow.
If you’re the kind of investor who gravitates toward cash flow and dividends, and you don’t necessarily mind modest growth, Verizon offers an awfully compelling income setup.
Financial Position
Verizon’s financial position is weak, and this is, arguably, the worst part about the business.
The long-term debt/equity ratio is 1.4, while the interest coverage ratio is just over 6.
The net unsecured debt/adjusted EBITDA ratio is approximately 2.6 as of the company’s most recent quarter (Q3).
In absolute terms, total long-term debt load is sitting at about $135 billion, which is a lot of debt – even for a company this large.
I’m not saying Verizon is in dire straits, but managing this massive debt load will limit Verizon’s ability to invest in the business and return cash to shareholders relative to what would otherwise be possible if the debt load were much lower.
Ultimately, that probably translates to the continuation of modest, low-single-digit dividend raises for the foreseeable future.
Profitability
The firm’s profitability, on the other hand, is surprisingly strong, showing just how alluring and in-demand this company’s services are to consumers.
Verizon’s ROE has averaged 28% over the last five years, while net margin has averaged 14.7%.
Being able to produce high returns on capital and reinvest at a decent growth rate will help Verizon to grow its way out of its debt hole.
Also helping are Verizon’s durable competitive advantages, including economies of scale, built-up infrastructure, and barriers to entry.
Risks
But there are risks to consider.
Competition, regulation, and litigation are omnipresent risks in every industry.
While competition among the incumbents in wireless is fierce, there’s an oligopoly in place that creates favorable economics for all major players.
Verizon has exposure to lead-sheathed cables, and it’s unknown at this time what, if any, ramifications and costs will stem from this issue.
Verizon’s balance sheet is heavily leveraged, and this is a significant drag on cash flow.
Continued buildout of infrastructure and spectrum is very expensive, further pressuring Verizon’s cost structure and balance sheet.
It’s possible that LEO satellites start to disrupt telecoms in the future.
All equities feature risks, and Verizon is no different.
Then again, if there were no risks, Verizon’s stock wouldn’t be yielding over 7%.
These risks also factor into the low valuation.
Valuation
The stock’s P/E ratio is just 7.3.
Yes, we have a case where the yield is higher than the P/E ratio.
Pretty incredible.
This is less than 1/3 of the broader market’s earnings multiple, and it’s also well below the stock’s own five-year average P/E ratio of 11.2.
The multiple of sales, at 1.1, is much lower than its own five-year average 1.6.
And the yield, as noted earlier, is significantly higher than its own recent historical average.
In order to estimate the intrinsic value of the business, I used a dividend discount model analysis.
The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.
The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.
It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.
I find it to be a fairly accurate way to value dividend growth stocks.
I factored in a 10% discount rate and a long-term dividend growth rate of 2.5%.
I’m assuming a continuation of the status quo here.
The dividend growth rate I’m modeling in is exactly in line with the dividend growth Verizon has demonstrated over the last decade.
It’s also very close to Verizon’s own EPS CAGR over the last 10 years.
I don’t see anything that would indicate a material acceleration or deceleration in Verizon’s overall growth profile.
Now, a low-single-digit growth rate isn’t much to hang one’s hat on.
However, it does keep up with inflation (under usual circumstances), which keeps one’s purchasing power intact.
And this is an income play, not a high-growth compounder, so we have to keep that monstrous 7.5% yield in mind at all times.
Not all investors need a lot of growth, and income-oriented investors should find plenty to agree with here.
The DDM analysis gives me a fair value of $36.35, which would indicate the stock is fairly priced.
Bottom line: Verizon Communications Inc. (VZ) is one of the best high-yield dividend growth stocks on the market for those who desire a large, reliable dividend to help pay the bills. If one is aiming to produce generous income from a portfolio without needing to sell off assets, this stock could get the job done very nicely. Investors get a well-covered 7.5% yield, and this payout is actually growing every year. The stock currently looks fairly priced, which means prospective investors could have a great opportunity on their hands to buy shares without overpaying.
-Jason Fieber
P.S. If you’d like access to my entire six-figure dividend growth stock portfolio, as well as stock trades I make with my own money, I’ve made all of that available exclusively through Patreon.
Source: Dividends & Income