On the income side of my portfolio, I look for companies with strong moats, growing revenue, positive net income, large amounts of Free Cash Flow (FCF), and a quality dividend. Verizon Communications (NYSE:VZ) checks off all of the boxes and is a quintessential income-producing equity that can become a cornerstone in any income portfolio. VZ may seem like a boring investment to some since it's not a SaaS or big tech company, grabbing headlines left and right. When I put my income investor hat on, VZ is a shining star that is absolutely exciting when I tear through the numbers.
When it comes to income-producing equities, I want to invest in companies that I believe have durable businesses and can last the test of time. I am not worried about capital appreciation; just the opposite, I want capital preservation over time with a growing dividend. The markets will fluctuate, and long-term investors will experience bear and bull markets. The trick for me is finding companies I can hold for decades where I can reinvest the dividends and increase my cash generation with minimal risk to the downside over time. Call me crazy, but I love VZ's chart over the past decade. It's a slow grind to the upside with rangebound fluctuation. This allows a respectable portion of the dividends to be reinvested at optimal prices during fluctuations to the downside. I don't believe anyone is worried about VZ going out of business as they have one of the largest moats with a product that has become a necessity.
Verizon Has A Tremendous Income And Cash Flow Statement
Technology has changed how we live. In 2002 the iPhone wasn't created, and Blackberry's were a dime a dozen. They weren't mainstream, and it was normal not to have a smartphone. Many people had an antiquated digital cell phone, and some still had analog phones. Fast forward 2 decades, and children are walking around with iPhones. Regular cell phones are obsolete, and it's not considered normal not to have a smartphone.
When I think about businesses with moats, I want to see a product or service absolutely needed by the masses, large entry barriers for new competitors, and a limited number of current competitors in the marketplace. Communication services have to be one of the best examples of an industry with a wide moat protecting current providers from outside competition. These barriers of entry are one of the toughest for any company that wants to compete with VZ, AT&T (T), or T-Mobile (TMUS). There are 2 main reasons why there isn't a large crop of providers to choose from, it's too expensive to build out the needed infrastructure, and the government hurdles are immense. A 4th mainstream provider is unlikely to emerge because even if they raised the capital to build out a wireless network, they still need to deal with government regulations, C-band auctions, create brand awareness, and go head-to-head with the VZ and T marketing machines, and building out a salesforce. This becomes a losing endeavor, and there is a reason why TMUS and Sprint merged. VZ, TMUS, and T will likely be the dominant carriers as the barriers of entry protect all 3 companies from outside competitors. They will likely continue to fight amongst themselves for new customers.
When I look at VZ's income statement, I see a strong company generating massive profits. VZ closed out 2021, generating $133.61 billion in revenue while producing $77.17 billion in gross profit. Its gross profit margin was 57.46%, validating its moat and meeting Mr. Buffett's 40% threshold. In 2021 VZ produced $21.4 billion in net income, creating a 15.93% profit margin. VZ finished 2021 generating $5.32 in EPS which was a YoY increase of 23.72%. As an established business, I am not necessarily too concerned with the YoY numbers as I am more interested in their ability to produce large amounts of FCF and net income. Excluding the TTM, VZ has generated $104.76 billion in net income over the past 5 fiscal years with an annual average of $20.95 billion. VZ is proving that no matter what the operating landscape looks like, its established track record of generating large amounts of revenue and profits will continue in future years to come.
FCF represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. FCF is a measure of profitability that excludes the non-cash expenses of the income statement and includes spending on equipment and assets as well as changes in working capital from the balance sheet. FCF could be the most underrated and most important financial metric to look at as this is the pool of capital utilized to repay debt, pay dividends, buyback shares, make acquisitions, or reinvest in the business. FCF is determined by subtracting capital expenditures from the cash generated by a company's operations.
In 2021 VZ generated $39.54 billion in cash from operations and spent $21.61 billion on CapEx. VZ generated $19.25 billion in FCF in 2021, providing a large pool of capital to strengthen their business and reward shareholders. The long-term history of cash from operations exceeding CapEx makes me confident in picking up shares of VZ on its decline. I believe the short-term headwinds will ultimately be short-term, and the long-term story is still beneficial for income investors.
Why Did Verizon Decline After Earnings?
Shares of VZ took a nosedive after Q1 2022 results hit the street and sold off by roughly -$8.71 or -15.83% per share. This was caused by VZ lowering its full-year forecasts, and the result was the worst drop that VZ's shares have seen since 2020. VZ had previously stated that it expected to generate between $5.40 - $5.55 per share in EPS and grow its wireless revenue by 9-10%. The street had estimated $5.44 for VZ's EPS in 2022. In the Q1 2022 earnings release, VZ indicated the following:
- Adjusted EPS will come in at the lower end of the $5.40 - $5.55 range
- Wireless revenue growth will come in at the lower end of the 9-10% range.
- Adjusted EBITDA growth will come in at the lower end of the 2-3% range.
VZ revised its previously forecasted outlook and prepared the street for the low-end of the metrics to be reached in 2022. The revised outlook was the main cause for the drastic decline in its share price following earnings. Since the decline, shares have regained roughly half of the value they shed since the earnings report.
Don't expect fireworks out of VZ in 2022, as the chances of them coming in on the high-end or completely beating their previous forecasts are slim. It was a smart move on VZ's part to revise its outlook in Q1, this way, the market can readjust its expectations, and this won't come as a shock later. This isn't good news for swing traders and short-term focused investors, but it doesn't matter for long-term income investors; it doesn't matter. Suppose you buy VZ as an income-producing asset. In that case, the current decline provides an opportunity to purchase shares cheap while allowing the dividends to acquire a larger amount of shares when they reinvest.
Verizon's Dividend Is Rock Solid And Should Be An Income-Producing Equity On Every Income Investor's Radar
What makes a quality dividend? I look for how large the yield is, the payout ratio, and the previous growth rates. I rarely invest in companies with lower than a 3% dividend yield when it comes to income investing. The reason is I can just buy the Schwab U.S Dividend Equity ETF (SCHD) and generate a 2.9% yield while getting exposure to 104 equities from this ETF. While I have a handful of investments, such as Cisco Systems (CSCO) and Intel Corporation (INTC), that generate in the low 3% yield range, I really want to see 4% plus yields from individual income investments.
VZ checks off all the boxes and is a quintessential income-producing investment that can be relied on. Over the past 2 decades, VZ has grown its dividend through every crisis, including the financial crisis, mortgage crisis, and pandemic. Investors have collected dividend income from VZ during good and bad times while being rewarded with annual increases.
Today shares of VZ trade at $50.81 and pay a dividend of $2.56 per share. This is a forward dividend yield of 5.04%, which is well above the 4% level I gravitate toward. VZ has a long track record of rewarding shareholders by paying out a portion of their EPS as a dividend. The payout ratio is critical to look at as I want to see 75% and under for normal equities. There are some exceptions, and I give companies such as Altria Group (MO) a pass, but my normal threshold is 75% and under. VZ has a payout ratio of 46.83%. The combination of a 5% dividend with a sub 50% payout ratio is rare. Such a low payout ratio indicates that VZ has more than enough room to continue its future annual dividend increases while leaving enough room to reinvest in the business or buy back shares. When it comes to dividend growth, VZ has a long-established track record and is well on its way to entering the Dividend Aristocrat club. VZ has grown its dividend sequentially for 18 years and has a 5-year average growth rate of 2.09%. I give VZ's dividend an A, and plan on adding more shares at these levels.
Conclusion
The chart indicates that the market overreacted to VZ's estimate revision. In the grand scheme of things, does it matter that VZ will come in on the low end of estimates in 2022? For my investment thesis, it doesn't. VZ has earned the right not to be sold off as heavily as it was on a revision that stays within its previous range. VZ didn't come out and say they would miss the low end of the range by 10%. VZ will still generate plenty of FCF and net income in 2022 to fund its dividend, CapEx and reinvest in the business. I am not investing in VZ for large amounts of capital appreciation, but I do expect VZ to grind higher over the next 5-10 years. From an income perspective, VZ is one of the highest quality income investments in the market. You're getting a 5% yield from a business with a large moat, and there are immense barriers to entry keeping new competitors from entering the market. VZ's dividend should continue to increase annually, and the current dividend payments will either provide large amounts of income or allow investors to repurchase shares at an attractive valuation and grow their future cash flow.
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