Better Buy: Verizon Communications Inc. vs. Philip Morris

6/23/17

By Dan Caplinger, Motley Fool

High-quality stocks with strong dividends are hard to come by, but both Verizon Communications (NYSE:VZ) and Philip Morris International (NYSE:PM) have the pedigrees that income investors want to see. With solid histories of dividend growth and attractive current yields, both Verizon and Philip Morris are blue-chip grade stocks that can fit in many investors' portfolios. Yet some of those following the two stocks worry about the respective challenges they each face, and that leaves would-be buyers in a position of deciding which one looks more promising. Below, we'll compare Verizon and Philip Morris by utilizing some useful measures of success, and then you can decide which stock makes more sense for your situation.

Stock performance and valuation

Verizon and Philip Morris have seen their stocks diverge sharply over the past year. Verizon has fallen more than 15% since June 2016, while Philip Morris has gained 18% over the same time period.

After having seen their shares move in essentially opposite directions, it's no surprise to see that valuations have moved away from each other as well. When you look at trailing earnings, Verizon looks like a relative bargain, trading at a trailing multiple of 15. By contrast, Philip Morris currently trades at nearly 27 times trailing earnings. That difference doesn't narrow when you take future earnings estimates into account. Philip Morris has a forward earnings multiple of 22, but Verizon weighs in at just half that number. Based on valuation, Verizon looks like the better pick over Philip Morris.

Verizon store.

IMAGE SOURCE: VERIZON COMMUNICATIONS.

Dividends

Verizon's weak share price performance has also given it a relative advantage in terms of dividend yield. Verizon has seen its yield climb to nearly 5%, while Philip Morris' yield has slumped to just 3.4%.

For a while, Philip Morris had much stronger dividend growth than Verizon, compensating in part for its lower yield. Double-digit percentage increases in dividends were common during the tobacco giant's first years as an independent publicly traded company. However, over the past couple of years, Philip Morris has only made small dividend increases of just 2%. That's roughly comparable to what Verizon has traditionally done, with the telecom company making 2% to 4% boosts in most years recently.

Going forward, Verizon's lower payout ratio of about 75% gives it somewhat more latitude for dividend growth. Philip Morris has a higher payout ratio, equal to about 90% of its earnings. Based both on current dividends and future payout prospects, Verizon again gets an edge.

Growth prospects and risk

Verizon and Philip Morris both have growth opportunities, but they also face challenges. For Verizon, the search for growth has led to a huge gamble. The telecom company paid $2.2 billion for Straight Path Communications (NYSEMKT:STRP) in an effort to build up its holdings of high-band spectrum. Verizon hopes to use Straight Path's assets to help build out Verizon's 5G network, and that will be crucial in order to differentiate Big Red from its rivals in the wireless mobile space. But until 5G becomes available -- and perhaps even afterward -- the competitive efforts of Verizon's rivals will pose a threat to pricing power throughout the industry. Verizon is trying to market its qualitative advantages over rival networks, but many customers have been willing in the past to accept slightly worse network quality in exchange for substantial savings. An ongoing price war won't be good for anyone in the industry, but it will hit Verizon and its premium offerings particularly hard.

Meanwhile, Philip Morris has seen a tough trend continue in recent months, as its first-quarter results showed double-digit drops in cigarette sales volumes. Declines came throughout the company's global reach, with both of Philip Morris' European segments faring particularly badly. Asia was a high point for Philip Morris, largely because the success of the iQOS heat-not-burn tobacco system has continued to surprise even the most optimistic of investors. Even though Philip Morris has ramped up production of iQOS in order to meet demand, however, the company's anticipated transition from traditional cigarettes to reduced-risk products likely won't happen fast enough to prevent what could be a disruptive drop in sales. Philip Morris must not only retain its own cigarette customers with iQOS but also woo smokers of other brands to the reduced-risk product. With rivals coming out with heated-tobacco products of their own, Philip Morris will have to work hard to preserve its first-mover advantage and keep up its momentum.

When you weigh advantages and challenges, Verizon looks like the better buy between these two stocks currently. Better valuations and higher dividend yields give Verizon a bigger margin of safety against potential adversity than Philip Morris has right now. Both stocks will have to push hard, however, in order to overcome the obstacles in their paths toward future growth.

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