AT&T has surprised me this morning as it has been consistently overvalued due to the demand for it’s high paying dividend. You see; when a company pays a reasonable dividend; investors, through supply and demand, push the price upwards to a more reasonable level of return, which is usually 2% to 4%.
So, if you buy a stock that is $100 with a $5 dividend; this represents a 5% annual return on investment. This is high so investors will usually buy in greater amounts to push the stock higher to a more reasonable return. For example; in the above scenario; you may see the stock pushed to $125 so that the $5 dividend yields 4% instead of 5%. Sometimes the yield stays steady though because of inherent risks associated with the company.
So what surprised me so much about AT&T? Well, AT&T pays 0.51 cents per quarter, which amounts to 2.04 per year. AT&T opened this morning at $30.90, which makes this dividend a 6.7% yield. What’s even more interesting is the Price to Earnings ratio of 20, which tells me the stock is fairly valued at $30.
After the believed synergy savings of the merger with Time Warner; AT&T should have enough cash flow to cover operations and the dividend. The big questions are the following:
- Will Investors push this stock higher to even out the dividend return despite the fact that the stock is fairly priced as is.
- If investors do not push the stock price higher; will AT&T continue to be a Dividend Champion with 35 years of Dividend increases or will they cut the dividend.
I do not know the answers to the above questions, but here is my guess. I believe question one is a definitive yes. If AT&T can support the dividend; there is no way anyone will let anyone else get a free pass on an “almost” guaranteed 7% return on investment. Based on their free cash flow; I believe the dividend is sustainable; so I believe the answer to number two is, “no.”
These are just my assumptions based on inherent knowledge I have gathered over the years. Make sure you do your own research and due diligence before you invest in anything. That being said, I plan to acquire more shares of AT&T myself.