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The telecommunications sector is a haven for income investors. For years, investors have counted on juicy dividend yields from telecom companies. Above-average yields across the sector are very common, since the most profitable U.S. telecom stocks like AT&T (NYSE: T) and Verizon Communications (NYSE: VZ) generate a lot of free cash flow.
Top Dow dividend stock Verizon is a cash machine. Its revenue and free cash flow growth lead its industry, which is a direct result of a key strategy decision made two years ago.
In 2013, Verizon agreed to acquire the remaining stake in Verizon Wireless from European telecom giant Vodafone (NASDAQ: VOD). Prior to the $130 billion acquisition, which closed in 2014, Verizon held a 55% majority stake in Verizon Wireless.
The strategic rationale behind the move was that Verizon Wireless is the largest and most profitable wireless carrier in the United States. Taking full ownership made a lot of sense, since it provides Verizon a great deal of financial scale, flexibility and operational efficiency.
Since the company acquired the remaining stake in Verizon Wireless from Vodafone, Verizon’s cash flow has soared. This has allowed its dividend growth to rise ahead of its peers, and its 4.5% current yield is secure.
Indeed, judging by Verizon’s results since the takeover, it’s clear the strategy was right on the money. Verizon’s total operating revenues in the fourth quarter of 2014 were $33.2 billion, which was 6.8% growth year-over-year. For the full year, operating revenues were $127.1 billion, up 5.4% percent.
Growth has been highest for the wireless business, which produced 11% revenue growth last quarter and 8% revenue growth in 2014. These results were much better than close peer AT&T experienced. In 2014, AT&T grew revenue by just 3%.
As a result, Verizon generated $13.4 billion of free cash flow last year. With its prodigious cash flow, Verizon is able to return a lot of cash to investors. The company paid $7.8 billion in dividends last year alone.
Verizon has invested a great deal of money in building the quality of its network. In 2014 alone, it invested $17.2 billion in its business infrastructure. Over the past three years, it has invested more than $50 billion in its network.
The company continues to upgrade its portfolio by divesting legacy wireline assets to free up additional cash to plow back into wireless growth. For example, Verizon recently sold $10.5 billion worth of wireline assets to Frontier Communications (NASDAQ: FTR).
It’s true that Verizon’s dividend yield is lower than AT&T’s, by about 100 basis points. But Verizon grows its dividend much faster than AT&T. Over the past five years, Verizon has grown its dividend by 4% compounded annually. This is about twice the rate of AT&T’s dividend growth in the same period.
Verizon grows its dividend faster than AT&T because the latter already distributes nearly all of its cash flow. In 2014, AT&T generated $9.9 billion of free cash flow and paid $9.6 billion in dividends. By contrast, Verizon distributed just 58% of its free cash flow last year. This should give Verizon ample room to continue increasing its dividend at much higher rates than its peer group in the years ahead.
Investors should also be confident in Verizon because the company has the backing of none other than Warren Buffett, the most famous investor of all time. Buffett’s Berkshire Hathaway (NYSE: BRK-B) purchased nearly 11 million shares of Verizon last year, representing a $530 million investment.
For all these reasons, investors looking for a stock that provides a high current yield, as well as industry-leading dividend growth, should take a closer look at Verizon.
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