If you come across a dividend stock with a yield exceeding 5%, it wouldn't be out of line to question whether its dividend is sustainable. And the higher that yield is, the greater the doubts that you have come across a safe income stock.
It's this truism that likely goes some way toward explaining why investors remain hesitant about AT&T (NYSE: T) stock. The stock itself trades down about 14% over the past 12 months. That drop in price has helped push its dividend yield up to 6.6%, which is more than 4 times the S&P 500 average yield of 1.4%.
Is AT&T's dividend yield too good to be true, or could this be a bargain stock for income investors to buy right now?
How risky is AT&T's dividend?
Simply looking at a stock's dividend yield isn't going to tell you whether it's safe. While it's true that high dividend yields are oftentimes unsustainable, there are plenty of situations where yields exceeding 6% can be safe. Sometimes, a stock's falling price pushes the yield up temporarily. For one reason or another, investors may simply not be all that bullish on a company's future, and that can leave an otherwise solid stock without the strong returns to match its rising dividend, resulting in a higher yield.
The fundamentals are what's important. And in January, AT&T seemingly demonstrated that its fundamentals are solid. When the company reported its fourth-quarter numbers, covering the last three months of 2023, the top line showed a modest 2.2% year-over-year revenue growth as it climbed to just over $32 billion. The company's operating income flipped from a loss a year ago to a profit of $5.3 billion. And free cash flow of $16.8 billion for the year topped the company's guidance.
Not only is the company generating more in free cash flow than it pays in dividends ($8.1 billion), but its payout ratio is also modest at less than 60%. Based on free cash flow and earnings, the dividend looks to be safe.
Is debt a big problem for AT&T?
The big number that's likely worrying investors is the company's large debt load. At $127.9 billion in long-term debt, AT&T hasn't made much of a dent -- its long-term debt totaled $128.4 billion a year earlier. And the company's debt-to-equity ratio is higher than it has normally been.
T Debt to Equity Ratio data by YCharts
There is some risk but it isn't a new one when it comes to telecom companies, which often have high debt loads and need to invest heavily in capital. Rival Verizon Communications, for example, has an even higher debt-to-equity ratio of 1.6.
Rising interest rates have undoubtedly made investors more bearish on telecom stocks given their debt loads, but it's arguably not a new risk for investors. It just may be more of a concern these days as interest costs run higher and excessive debt amounts could limit the opportunity for dividend growth -- AT&T hasn't increased its dividend since it adjusted its payout after the WarnerMedia spinoff took place in 2022.
Should you buy AT&T stock for its dividend?
AT&T's dividend doesn't appear to be in any danger right now. While the business does face some risks with respect to its high debt, strong free cash flow is a positive sign for the company that suggests it can bring down its debt and still pay a dividend for the foreseeable future.
If interest rates eventually start to come down, I believe more investors will start to buy up AT&T stock. If you buy the stock before that happens, you can help set yourself up for some good gains in addition to all the dividend income you might accumulate from this investment. Trading at just 9 times earnings, this can indeed be a bargain dividend stock to buy right now.
Should you invest $1,000 in AT&T right now?
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David Jagielski has no position in any of the stocks mentioned. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.
