At the top of the reasons to invest in AT&T’s (T -0.27%) stock is its juicy 7.9% dividend yield. However, many investors have been taught that they should proceed cautiously once a stock’s dividend gets above a 5% to 6% yield. Normally, you see these yields on lesser-known businesses, but not on giants like AT&T.
So, what’s happening with AT&T, and should you avoid the stock? Read on to find out.
AT&T’s debt is becoming a heavy burden
The dividend yield is a simple calculation: The annual dividend divided by the stock price. AT&T raised its dividend steadily for years, and its yield rose to more than 10% in late 2021.
However, after AT&T spun off several of its business segments (such as DirecTV and Warner Brothers), it no longer had the income to maintain its previous payout and cut its dividend. But even before that, seeing AT&T’s stock with a 6% to 8% yield wasn’t uncommon, so this isn’t uncharted territory for it. Unfortunately, AT&T’s dividend payout remained elevated at the same time it raised its dividend because the stock price declined steadily.
Over the past decade, AT&T’s stock has lost nearly 50% of its value. This is primarily because investors believe there are better investment opportunities out there, and they’ve been right.
AT&T’s biggest problem has been its unhealthy debt load, as the company must heavily utilize debt to subsidize growth. As a result, its debt has nearly doubled over the past decade (although it recently declined when it spun off the businesses mentioned above).
This has become a burden on AT&T’s finances, as second-quarter interest expense was $1.7 billion, eating significantly into its $6 billion operating profit. With other line items adding and subtracting slightly, AT&T produced net income of $4.4 billion.
However, AT&T paid $2.1 billion in dividends, leaving nearly $2.3 billion left over at the end of the quarter. Even if AT&T plowed all $2.3 billion into repaying its $240 billion debt, it would take more than 25 years to repay it.
But that’s only if AT&T doesn’t issue any more debt.
Over the past year, AT&T issued more debt than it has retired, causing its total debt to increase. The ultimate reason for the pessimism behind AT&T stock is that eventually, it will reach a tipping point where interest payments will become so high that the company cannot afford its dividend. When this happens, AT&T’s stock will drop like a rock, as the only reason to purchase the stock has been its dividend.
But there’s another side to this argument.
AT&T is historically cheap
The stock is extremely cheap because most of the market is bearish on AT&T. At just 5.8 times forward earnings recently, AT&T’s stock can be purchased for practically nothing. However, it is always cheap because of AT&T’s historically poor performance against the broader market.
So, should you buy AT&T’s stock? I’d say no. Even though AT&T will likely be able to pay its dividend for some time, it’s unlikely the stock will turn around and gain value. The stock usually loses more in a year than it pays out, so it becomes a losing investment.
As a result, investors shouldn’t get distracted by the dividend yield and focus on why it’s so high. If you do that, you’ll quickly become worried about AT&T stock and begin to look elsewhere.
Keithen Drury has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Warner Bros. Discovery. The Motley Fool has a disclosure policy.