AT&T's 6.0% Dividend Yield and Low P/E Are Attracting Value Buyers

AT&T (T) stock now trades at a 6.0% dividend yield and a low forward price-to-earnings (P/E) multiple. This is attracting value buyers to T stock along with its ample free cash flow (FCF). Long-term investors in the stock also can use covered calls as another way to generate income.

As of Friday, Dec. 16, AT&T stock was trading at $18.49. Given its $1.11 annual dividend, T stock has a 6.0% dividend yield. In addition, analysts project earnings next year will stay fairly steady at $2.58, down only slightly from the $2.61 earnings per share (EPS) forecast for this year. That puts the stock on a cheap forward P/E multiple of just 7.2x.

Fundamentals Cover The Dividend

Moreover, AT&T said during its conference call on Oct. 20 for Q3 that its FCF was sufficient to cover the dividend. It generated $3.8 billion in FCF during the quarter. This more than covers the $2.0 billion in quarterly dividends (or $8 billion annually).

So, there should not be a great deal of concern that AT&T will cut the dividend going forward. However, in the past 5 years, the average dividend yield has been at 6.97% according to Morningstar. But that was before the dividend was cut 46.7% from $2.08 annually to just $1.11, and it was clear the company could not afford to keep paying this high level.

Moreover, the stock's forward P/E is now well below its historical average. Morningstar says that the average forward P/E for the past 5 years was 8.92x. So, today's forward multiple of 7.2 is well below this level. It implies that the stock could rise 23.9% just to get to its historical average multiple. 

That implies that T stock could rise to $23.00 (i.e., 8.92x $2.58 EPS). We can use this to look at shorting out-of-the-money covered calls in T stocks.

Covered Calls in T Stock Look Attractive

On Friday, Dec. 16, the Jan. 27 call options at the $19.50 strike price have a mid-price premium of 15 cents per call option contract. That works out to an attractive immediate return of 0.81%, or an annualized return of 9.7% assuming it can be replicated each month.

Here is what this means. If an investor buys 100 shares of the stock at $18.49 for $1,849 in their brokerage account, they can immediately sell the Jan. 27 $19.50 calls and receive $15 in their account. Since $15 divided by $1,849 is 0.81%, the annualized return is 9.7%.

But even more importantly the investor gains a slightly higher dividend yield on an ongoing basis. For example, let's say that the investor can repeat this transaction over the next three months. That means the investor gains $45 income and effectively lowers his investment cost to just $1,805 (i.e., $1,849 - $45). This means that the annual $111 in dividend income is now 6.15% of his or her investment cost. That is higher than the original 6.0% dividend yield.

This assumes that AT&T stock does not rise to $19.50 or higher in the next 3 months. But even if it does, the investor will make an additional 5.46% capital gain on his investment. The only major risk is that the stock rises to a price much higher than $19.50. Assuming the investor considers that lost capital gain a high probability this risk may be too high. 

But for many investors, this is probably not a high risk, since, as pointed out above the earnings and cash flow for AT&T seem to be fairly stable. As a result, covered calls look like a good way to make additional income with a long-term investment in AT&T stock.

• Stocks Fall as Fed Officials Reinforce Hawkish Views
• Does the Sugar Market Symbol, SB, Symbolize Sugar Bulls?
• Competition Weighs on Chinese Electric Vehicle Makers
• Stocks Fall as Central Banks Remain Hawkish