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Investing, Stocks  | January 23, 2019

Summary

  • AT&T combines many positives that income investors usually seek.
  • AT&T will not make you rich in a short period of time.
  • Expecting 100,000 in annual dividend proceeds is not realistic unless one has an ultra long-term view.

Thesis

AT&T (T) is one of the favorite income stocks for many retail investors, and rightfully so: The company combines a long dividend growth record, a relatively high current dividend yield, and resilience versus recessions and economic downturns. Income investors should be careful not to make assumptions that are too optimistic, though.

In a recent article here on Seeking Alpha, the assumptions were too aggressive, and the conclusion that investors can generate $100,000+ in annual dividends in 15 years by investing a small amount of cash each quarter does not seem realistic, I believe. I will show my models and assumptions in this article so investors can draw their own conclusions regarding the income generation power that AT&T will offer during the coming years and decades.

Why AT&T has Rightfully Become a Widely-held Income Stock

When investors who put a focus on income generation look at stocks, they oftentimes have relatively similar pointers they are looking for. These include the current income yield (the higher the better), a long and consistent dividend growth track record (the longer the better), and a dividend that is safe even during economic downturns or a financial crisis.

AT&T scores well based on these metrics:

  • The company's dividend yield is 6.6% right now, which is more than 3 times the broad market's yield, and which offers a lot of income from the beginning.
  • AT&T has a long and steady dividend growth track record, as can be seen in the following chart:

The outlier in the early 2000s is based on special dividend payments during that year, the regular dividend has never been cut during the last decades.

  • AT&T remained highly profitable during the last financial crisis. This is not really surprising, as demand for AT&T's offerings is not cyclical. During a recession, consumers might cut back on items such as new vehicle purchases or travel and recreation, but almost no one stops using a cell phone. Over the last couple of years, smartphones have become an increasingly important part of our daily lives, thus the resilience of AT&T versus economic downturns has likely improved further. During the last financial crisis, AT&T's earnings per share dropped from $2.16 (2008) to $2.12 (2009), before rising to $2.29 in 2010. AT&T's resilience makes its dividend look relatively safe for the future.

These factors make AT&T an attractive dividend growth investment, although investors should keep a couple of negatives in mind as well.

The first one is that AT&T's dividend growth rate has slowed down considerably over the last couple of years, more recently the inflation-adjusted dividend growth rate was close to zero:

As AT&T has been sticking with annual dividend increases of $0.04 per share, the dividend growth rate has declined very consistently, to just 2.1% during the last year. Unless AT&T starts to increase its dividend by more than $0.04 per share in the future, the dividend growth rate will decline further. As the dividend growth rate is relatively on par with the rate of inflation right now, investors do not see any dividend growth in real dollars any longer, at least when we exclude the impact of dividend reinvesting.

Another negative is AT&T's weak total return performance over the last couple of years:

Over the last five years, AT&T has produced total returns of just 20%, whereas the broad market produced total returns that were three times as high. Since early 2000 AT&T has delivered total returns of 65%, whereas the broad market has returned 160% during those 19 years. Despite the strong dividend growth track record, AT&T has been a relatively weak investment in the past, which was at least partially due to mistakes that AT&T's management has made (overpaying for DirecTV, non-profitable ventures into Latin American countries).

Projections About AT&T's Dividend Growth

AT&T's profits rose substantially during 2018, but that was at least partially based on tax law changes. Going forward AT&T will not grow its earnings per share at an overly large pace. At the same time management wants to lower the company's debt levels considerably, which is an opportune move. This deleveraging will soak up a considerable amount of AT&T's cash flows. It thus seems likely that AT&T's dividend growth will not accelerate going forward, management will likely continue to raise the dividend by 4 cents a year for the foreseeable future. This would lead to the following payouts during the future:

Source: Author's calculation, assuming the dividend gets grown in line with the recent growth trend

We see that the dividend growth rate continues to drop consistently, and unless management decides to accelerate the dividend growth rate considerably, the dividend growth rate will remain below 2% going forward.

AT&T has delivered a higher dividend growth rate during the past, especially before the 2000s, but it is not realistic to assume that the dividend growth rate will be significantly higher than 2% going forward, I believe.

What Happens If You Put $100 Into AT&T Each Quarter?

In this article, the author, Robert Allan Schwartz, shows his model that concludes that a $100 quarterly investment allows for massive annual income generation 15 years down the road. He concludes that a stagnant share price is not necessarily bad, and that it can actually help in generating higher income. This is based on the fact that reinvesting dividends has a bigger impact if the share price does not rise. I agree with this statement and the overall conclusion, but I believe that the $100,000 income goal is much harder to achieve. I have built the following model:

Source: Author's calculation

Assumptions:

- AT&T continues to raise its dividend by $0.04 every year, in line with historic trends

- Share price remains at $31

- The investor puts $100 per quarter ($400 per year) into AT&T, this amount rises by 3% a year

- All dividend proceeds are reinvested

We see that the number of AT&T shares that the investor holds rises quickly, from 13 at the end of year 1 to 933 at the end of year 22 (2040). The dividend income rises quite fast as well, from $26 during 2019 to ~$2700 in 2040.

The investor does not hit the $100,000 annual income goal during the next 15 years, though. It would take 50 years, or until 2069, for an investor to cross the $100,000 annual income line (during that year the investor would generate ~$105,000 in annual income).

Investing and waiting for 50 years is likely not a viable approach for most, but luckily there are ways to accelerate this process. One could, for example, increase the savings rate. If an investor puts $1200 into AT&T each year (or $100 a month), things move much faster. By 2040 one would already generate annual dividend proceeds of $7,700. When we increase the savings rate further, to $300 a month, one would generate annual dividend proceeds of $22,700 by 2040, and the $100,000 line would be crossed in 2052.

Alternatively, things do also move significantly faster if one already holds a position in AT&T. If, for example, an investor invests $100 of new cash per quarter (or $33 per month), but the investor already holds 500 shares (about $15,000 worth of stock), dividend proceeds during 2040 would total $9800.

When we combine a starting investment of 500 shares with a monthly savings rate of $300, dividend proceeds would total ~$30,0When we combine a starting investment of 500 shares with a monthly savings rate of $30,000 in 2040, and the $100,000 line would be crossed in roughly 30 years.

To sum things up: Investing a small amount of cash each month does not lead to massive income generation during the next 10-20 years. By investing regularly, investors can still generate a sizeable income stream over a longer period of time. It would not necessarily be a problem if AT&T's share price stays where it is, this would actually make dividend reinvesting more potent.

Takeaway

AT&T is a solid income stock, and it combines several positives that income-focused investors usually seek from their investment, such as a high initial dividend yield and resilience versus recessions.

AT&T is not a wonder stock that will make you rich in a short period of time, though, and generating $100,000 or more in annual dividend proceeds will take a very long time, I believe.

Saving regularly and investing into dividend stocks is a smart strategy, I think, but it will still take several decades or a high savings rate for an investor to accumulate a massive income portfolio.


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