Verizon(NYSE: VZ) pays a monster dividend. The telecom giant yields 6.7%, several times above the S&P 500's 1.4% dividend yield.
On one hand, a high dividend yield is often a warning sign that the payout is at a higher risk of getting cut if market conditions deteriorate. However, that couldn't be farther from the truth for Verizon's healthy and secure dividend. That's one of the many reasons I continue to buy shares of the big-time dividend stock.
The numbers continue to get better
Verizon has spent the past several years investing in its network, including building out its faster 5G capabilities. That heavy investment phase is now in the rearview mirror, enabling the company to generate more free cash flow. For example, it produced $2.7 billion in free cash flow during the first quarter, a $400 million year-over-year improvement despite generating less cash flow from operations.
While free cash flow in the quarter didn't cover Verizon's dividend payment of $2.8 billion, that's not a concern because it's a seasonally low period for the telecom giant. Verizon expects its free cash flow to build throughout the year, as in 2023. Last year, the company produced $18.7 billion in free cash flow, easily covering its $11 billion dividend outlay.
Verizon's strong and growing free cash flow "supports both our dividend and a stronger balance sheet," stated CEO Hans Vestberg on the company's recent first-quarter earnings conference call. "This gives us greater flexibility to accelerate deleveraging throughout the second half of the year, bringing us closer to our long-term leverage target."
The company ended the first quarter with a leverage ratio of 2.6, an improvement from 2.7 in the year-ago period. That brings it one step closer to its long-term target of 1.75 to 2, which it aims to achieve next year. The company's solid and improving leverage ratio back its A-rated credit.
The "dividend is healthy and secure"
Verizon's improving free cash flow and strengthening balance sheet mean one thing. "Our dividend is healthy and secure," stated the CEO on the first-quarter call. Meanwhile, with its free cash flow dividend payout ratio also continuing to improve, Verizon's payout is steadily growing stronger.
That will continue putting the company in a position to increase its dividend, which it has done for a sector-leading 17 straight years. While the company's dividend growth has been modest in recent years, and less than 2% in late 2023, it's still rising. That's better than rival AT&T, which cut its dividend a few years ago and hasn't increased it since.
A new catalyst could soon emerge
While Verizon's improving financial profile and growing dividend are two of the biggest reasons I keep buying shares, they're not the only ones. The company trades at an extremely cheap valuation. At less than nine times its forward P/E ratio, Verizon trades at a more than 50% discount to the S&P 500 and its nearly 21 times forward P/E, and the Nasdaq-100 with its forward P/E of over 26. That low valuation is the reason Verizon has such a high dividend yield.
Verizon could soon be in the position to capitalize on this disconnect by starting to repurchase its dirt cheap shares. The company wants to get leverage closer to its target range before resuming share repurchases. That could happen next year. Buying back shares would help boost its earnings per share and its valuation.
A safe dividend with an upside catalyst
Verizon currently offers a big-time dividend yield primarily because of its low valuation. That payout is healthy and secure thanks to the company's improving free cash flow and leverage ratio. Those improvements could soon put it in the position to start repurchasing some of its dirt cheap stock. That combination of a sustainable income stream with an upside catalyst is driving me to buy shares hand over fist while they remain cheap.
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Matt DiLallo has positions in Verizon Communications. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.
