Inelastic Demand Allows Telecom Companies to Offer Attractive Dividend Yields

The telecom sector, which includes long-distance carriers and wireless communications companies, has historically paid higher dividends to investors. One may wonder why top-tier telecom companies like AT&T Inc (T ) and Verizon Communications (VZ ) are famous among savvy dividend investors for consistently yielding high dividends.

According to estimates from Morningstar and Gurufocus, larger players in the telecommunications industry like AT&T Inc have a median dividend yield of 5.29% in the last 10-year period, and in the last five years, yielded 5.12% on average. Verizon Communications is another big telecom company that yielded 4.45% on average during the last five years. VZ’s 10-year average dividend yield sits at 4.87%.

Smaller regional telecom companies currently yield higher compared to the larger companies that operate nationwide. For instance, Connecticut-based Frontier Communications (FTR ) operates in 28 states in the U.S. and currently yields an unsustainably high, yet true, 30.89%. Even telecom companies that operate in mostly rural America like Consolidated Communications Holdings (CNSL) currently yield 12.58%.

Currently, the telecom sector in the U.S. has an average yield of 4.36%. By contrast, at the end of December 2017, the average yield of the S&P 500 index was at 1.85%. Similarly, the dividend yield of the telecom sector exceeds the Dow Utility dividend yield of 3.44%.

Let us explore the rationale behind relatively higher dividend yields of the U.S. telecom sector compared to the broader market.

Explore some of the other domestic telecom companies from this list that pay above-average dividends to their investors.

Back in the 1980s, landline telephones were still a need as opposed to a want. Back then, cell phones came with their own briefcases and weighed more than the aggregate weight of a couple of modern-day laptops. The point is that the telecommunications sector served a vital need for the population in America since telephones became part of our daily live, and is now required for any modern economy to function properly.

Hence, both household and commercial entities continued to use telecommunication services regardless of the state of the economy. When people lose their jobs, they might cut back on restaurant meals or reduce their other expenses to cope with the unpredictable household income. However, one thing most people don’t easily give up is their home phone or personal cell phone. As far as economic jargons are concerned, the demand for phone and internet services are as inelastic as it gets.

This inelastic demand has allowed companies in the telecom sector to achieve predictably high profit margins, which have allowed them to pay higher dividends compared to other sectors.

Although telecom companies pay substantial dividends, most investors also want to make sure that these companies are growing at the same time. Since the profit retention rate of telecom companies has remained historically low, it is a concern for growth investors that telecom companies might not be keeping enough cash on hand to re-invest and grow their business in order to pay even higher dividends down the road.

Since cell phones, cable channels and internet connections have become a necessity for most people these days, the telecom companies hardly experience massive volatility in their quarter-to-quarter earnings. Hence, life is much easier for telecom executives as they don’t have much difficulty predicting future cash flows.

As telecom companies don’t have to keep a large cash reserve because of predictable cash flows, most companies in the sector can afford to distribute a large part of their profits among shareholders in terms of dividends. In addition, often they can also initiate share repurchase programs to boost shareholder value.

Since AT&T Inc and Verizon Communications are two of the largest companies in the sector, it is worth analysing their historical dividend-growth patterns. While AT&T Inc has over three decades of dividend-growth history, Verizon Communications managed to increase dividend payments for just over a decade in a row.

The foreign telecom services sector only yields around 1.60% on average, but some of the individual foreign telecom companies pay very attractive dividend to investors. Click here to explore these stocks.

Use the Dividend Screener to find high-quality telecom dividend stocks based upon 16 parameters. For instance, you can create this list by selecting domestic and foreign telecom stocks and download this screener result on a searchable spreadsheet to perform custom analysis. You can even screen stocks with DARS ratings above a certain threshold. Stocks with the highest DARS ratings are Dividend.com’s current recommendations to investors.

Once landline phones went out of fashion, telecom companies still kept their market share by offering more innovative technological solutions to people’s needs. With the proliferation of the wireless internet, they managed to keep the revenue flowing by offering data-related services when customers reduced calling via their phone subscription plan and started using VoIP & online chat services.

To keep the growth momentum steady, telecom companies have tried to diversify their business in recent years. For example, in 2015, AT&T Inc acquired pay-TV company DirecTV for $49 billion. They are also planning to buy Time Warner (TWX) for $85 billion if the company manages to resolve ongoing antitrust claims.

With the introduction of 5G mobile Internet and loosening government regulation around "net neutrality,” telecom companies can potentially claim a substantial portion of the media revenues. That’s where the revenue growth, increased profits and, eventually, dividend growth will come from.

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Predictable cash flows are one of the prerequisites of high dividend yields. So, it is not a surprise that other companies that make large dividend payments to their investors belong to the utility and real estate investment trust (REIT) sectors. Consider this: According to Lecturer of Corporate Finance and Valuation, Aswath Damodaran, at the Stern School of Business at New York University, the REIT sector paid the second highest (3.91%) dividend, followed by the tobacco sector (3.75%), in January 2018.

Telecom companies have a long history of paying some of the highest dividends to their investors and with the diversification efforts of large companies like AT&T Inc and Verizon Communications, there is a good possibility that this sector will continue to lead the market in coming decades. However, if you want to diversify your own portfolio to include other high-yield stocks, look for sectors where the demand for products or services is inelastic and offer predictable free cash flows.

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