On the surface, Verizon Communications (NYSE:VZ) may seem like an appealing buy for value investors. VZ stock trades at a very low price-to-earnings ratio, with a forward earnings multiple of only 7.2.
Not only that, shares in this telecom giant also sport a dividend yield that’s undeniably high, even in today’s high interest rate environment. VZ has a forward dividend yield of 7.86%.
But before you run out and possibly buy this stock, on the view that its valuation has nowhere to go but up, and its high payout will provide you with a steady baseline of returns, think otherwise.
With valuation, it’s possible that, rather than being very undervalued, VZ is instead slightly overvalued, and at risk of another price correction.
As for its high-yield? With this large payout comes an even larger dose of uncertainty.
VZ Stock: A Low Valuation Can Deceive
Verizon trades at a low multiple, but don’t assume this makes it undervalued. While there are some exceptions, low multiples aren’t out of the ordinary with telecom stocks. This makes sense, given the mature (i.e. low growth) and capital-intensive nature of the industry.
In fact, compared to other major telecom names, like AT&T (NYSE:T), VZ stock trades at a premium, as T stock trades for only 6 times forward earnings. Now, it’s possible that this valuation gap exists because of differences in dividend yield. Or, due to the perception that this telecom firm is facing fewer challenges than “Ma Bell.”
However, it’s tough to find backing for either argument. While T stock has a lower forward dividend yield (7.59%), it’s not that much lower than VZ’s yield. AT&T has been contending with issues like a heavy debt load and slowing subscriber growth, but it’s not like Verizon is in that much better of a situation.
As seen in recent results, revenue and earnings have been declining. Also, like I pointed out recently, the company may have an environmental issue on its hands, and a debt problem of its own.
What May Make this No-So-Cheap Stock Even Cheaper
VZ stock has already experienced several rounds of valuation contraction. Back in 2019, this stock traded for just over 12 times earnings. In 2021, VZ was trading at a P/E ratio of around 9.
But even after these prior valuation drops, another one may be around the corner, given that the valuation gap between VZ and T may not be sustainable.
While it is possible T’s valuation climbs up closer to that of VZ, given the similar challenges both companies are facing, a move by VZ down towards a valuation on par with that of T may be far more likely.
Based on current earnings per share forecasts for Verizon this year ($4.71 per share), this would mean a drop from $34 per share, to around $28.25 per share, or a 16.9% price decline. Such a pullback would of course outweigh the aforementioned 7.86% annual payout.
Speaking of which, remember I said there’s high uncertainty surrounding the dividend? I have talked of VZ’s “dividend trap” status before, and this risk has unfortunately not gone away. Much like AT&T has reduced its dividend to pay down debt/invest in growth, Verizon may follow suit.
The Bottom Line
With so many holding VZ just for the dividend, any sort of cut to its payout could cause an even more significant sell-off for shares. If the company’s other issues don’t lead to VZ’s valuation falling down to that of T stock, a dividend cut certainly would.
Many times with stocks, it’s possible to make as strong of a bull case as it is to make a bear case. With Verizon, however, things are pretty cut-and-dry.
Best case scenario, further slight price declines will outweigh gains from the stock’s 7.86% dividend. Worst case scenario, Verizon reduces the dividend/otherwise experiences additional multiple compression, resulting in even heavier losses for investors buying today.
Although this is not a high-risk stock, with such unappealing reward potential, consider it best to skip out on VZ stock.
VZ stock earns a D rating in Portfolio Grader.
On the date of publication, neither Louis Navellier nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in this article.