Yield-Seeking Investors Turn to Phone Stocks

Willing to give up the prospect of faster earnings growth for the current income offered by dividends, investors are driving the biggest rally for telephone stocks in seven years. Verizon Communications (VZ) and Hong Kong-based PCCW have led a 21 percent gain in MSCI's gauge of 52 global telecommunications companies since the end of the second quarter, even as analysts estimate that the group's earnings will grow at less than half the pace of the MSCI (MXB) World Index of stocks in 24 developed nations, data compiled by Bloomberg show.

Dividend yields of phone companies from Royal KPN to AT&T (T) pay more than their own bonds, leading some money managers to favor equities over fixed-income securities. "I know they don't have earnings growth, but I am not buying them for growth but for their very high, abnormal dividend," says Jacob De Tusch-Lec, a fund manager at Artemis Investment Management in London, which oversees $16 billion.

"The value of dividends has been highlighted by the environment, and first and foremost is just the low yields on competing assets," says Dan Hanson, a portfolio manager at New York-based BlackRock (BLK), which oversees $3.2 trillion. The average yield on investment-grade U.S. corporate debt hit a record low of 3.57 percent recently, according to data compiled by Bank of America (BAC). Sixty-nine companies in the Standard & Poor's 500-stock index paid a dividend yield above the average interest rate on corporate debt as of Oct. 8, the highest number in at least 15 years, data compiled by Bloomberg and Bank of America show. Telephone companies, long known for generous yields, account for 5 of the 10 largest payouts in the S&P 500 and yield 5.4 percent on average.

In the aftermath of the financial crisis, tech stocks have eclipsed financial stocks as dividend payers. Stocks in the information technology group accounted for 9.2 percent of the $210 billion in dividends paid out as of Oct. 11, compared with 8.9 percent for financial stocks, according to data compiled by S&P (MHP). In 2007, before the recession, financial stocks contributed 30 percent of dividends and info tech 5.7 percent. The average yield for tech stocks that pay dividends is 1.85 percent, compared with 1.37 percent for financial stocks.

Investors are snapping up dividend stocks despite the uncertainty over taxes: Reductions in levies on capital gains and dividends enacted in 2003 will expire on Dec. 31 unless Congress extends them. Even so, investors put more money into the S&P 500's dividend exchange-traded fund, the SPDR S&P Dividend, last month than ever before, while the Dow Jones industrial average's dividend ETF, the iShares DJ Select Dividend Index, had its best month since January 2005, IndexUniverse.com data show.

Is the focus on dividends shortsighted? U.S. phone stocks trade at an average 16.5 times earnings as of Oct. 11, the highest valuation of any S&P industry group. Telephone companies are the only group that analysts project will post a drop in third-quarter and full-year earnings. Profits fell 8.1 percent in the July-to-September period and will decrease 4.2 percent for all of 2010, according to the average estimates in Bloomberg surveys. Earnings for the entire S&P 500 climbed 23 percent last quarter and will grow 35 percent this year. "For an extra 1 percentage point of dividend yield, they may be sacrificing 2 percentage points of growth potential," says Bruce McCain, who oversees $25 billion as chief investment strategist at the private banking unit of KeyCorp in Cleveland. "It's just an emotional reaction that they feel more comfortable with the higher yield."

The bottom line: With interest rates low and stock prices stagnating, investors are drawn to high-yielding equities—and phone stocks are benefiting.

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