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How to Invest in Telecom Stocks After the AT&T/DirecTV Merger

Buy what you know is a tried-and-true investing approach popularized by venerable stock picker Peter Lynch in the 1980s. The idea is that investors should buy stock in companies they know and understand.

An updated version may be buy what you use.

Bargain-hunting investors looking for value and income can consider the telecommunications sector, bullish analysts say. This sector includes both wireless and broadband cable companies that serve millions of households. And they're particularly hot stocks now following last week's announced merger between sector giants AT&T (T) and DirecTV (DTV).

Stock

Share Price

Dividend Yield

AT&T

$34.59

5.45%

Verizon Communications

$46.03

4.77%

Comcast

$61.59

1.62%

Charter Communications

$181.93

0.1%

Time Warner Cable

$187.92

1.59%

Frontier

$4.55

9.27%

CenturyLink

$28.11

7.7%

What's in your pocket now? While it may not be sexy, telecom stocks are viewed as solid, safe-haven plays for investors seeking a reliable and generally large dividend payout. The two biggest companies in this sector are household names AT&T and Verizon Communications (VZ).

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After all, who doesn't have a smartphone today? "In this day and age, you need Internet access. You need phone service. Smartphones have become an increasingly indispensable tool. More people might be willing to give up their car over their cellphone," says Patrick J. O'Hare, chief market analyst at Briefing.com, a Chicago-based live market analysis company.

"Telecom is an area that provides investors an opportunity to capitalize on high-yielding names and the potential for capital appreciation. As returns in the overall market become more challenging to find, the higher dividend plays become more interesting," says Angelo Zino, senior industry analyst, equity research at S&P Capital IQ.

Telecom stocks offer defense and more. Traditionally, the telecom sector is viewed as a defensive sector, or a place for investors to park cash during times of market uncertainty. Exposure to telecom stocks can offer investors protection from volatility, income and the potential for capital appreciation, analysts say.

"Demand for telecom services typically doesn't fluctuate much with the state of the economy. Wireless service and Internet access, in particular, are viewed as necessary utilities. Consumers cut back on services at the margin during times of economic stress, but eliminating services entirely typically isn't an option for most folks," says Michael Hodel, strategist at Chicago-based Morningstar, an investment research firm.

A steady track record of high dividend payouts. Hefty dividend payouts are the typical attraction to the telecom sector. "These are established companies that generate a huge amount of cash flow and have the ability to pay out a lot of their earnings in dividends. They are attractive as an income play, and there is capital appreciation potential in the names," O'Hare says.

"AT&T and Verizon both have long dividend track records. Comcast (CMCSA) is building a strong dividend record as well. Smaller firms like Frontier also pay out very generous dividends," Hodel says.

S&P Capital IQ, a financial information provider, recently upgraded its investment outlook for the Standard & Poor's 500 telecom sector from "underweight" to "overweight." Out of the 10 S&P 500 sectors, S&P Capital IQ has only two as overweight: health care and telecom services.

The sector is attractively valued with the cheapest price-to-earnings ratio of the 10 stock sectors, Zino says. "We went from being bearish to bullish. As this upward cycle gets long in the tooth, the yield you can capture with telecom names provides a nice attractive play for investors."

Mergers and acquisitions could boost stock prices. There have been two major mergers in the telecom arena, with the possibility of more. Charter Communications (CHTR) announced a $78.7 billion merger with Time Warner Cable (TMC) in May, and federal regulators last week approved AT&T's $49 billion deal to buy DirecTV.

"The acquisition of DirectTV adds 20 million U.S. satellite subscribers and 19.5 million Latin American subscribers to the AT&T family. The deal offers not only greater scale, but provides further international expansion for AT&T, which is critical as it provides revenue diversification," Zino says.

"AT&T comprises over 40 percent of the S&P 500 telecom sector. We remain positive on the acquisition, and we expect in coming weeks to see new bundling options and cost synergies that will provide greater earnings potential and great free cash flow potential over time. This will be important for investors because we expect it to further solidify the attractive dividend yield, which is currently 5.5 percent," Zino says.

Telecom stocks. Frontier Communications (FTR) provides data, Internet, and local and long-distance voice services. S&P Capital upgraded its outlook from a "hold" to a "strong buy" on FTR stock. "We think now is a good time to get in on this name," Zino says. S&P Capital IQ has a 12-month target at $6.50. The stock recently traded at $4.55 and offers a dividend yield of 9.27 percent.

"We look for 30 percent capital appreciation and an 8 percent dividend yield. You'd be hard-pressed to find a name that can offer that income and capital on a return basis," Zino says.

Other telecom stocks that analysts recommend now include industry stalwarts AT&T and Verizon. "We have been overweight in this sector for over 10 years," says Kim Forrest, vice president and senior analyst at Fort Pitt Capital Group in Pittsburgh. "We still like the leaders in domestic wireless, as the mobile device is something people cannot live without. AT&T and Verizon have been our core holdings in this area."

S&P Capital IQ has issued a "buy" recommendation on AT&T, with a 12-month target at $39, up from its current $34.59. The current dividend yield stands at 5.45 percent. "It is an attractively valued, high-dividend name," Zino says.

CenturyLink Inc. (CTL) provides communications broadband services and is rated a "strong buy" by S&P Capital IQ. The firm has a 12-month target at $45, up from its current $28.11. The stock has a 7.7 percent dividend yield. "We believe the yields are very sustainable," Zino says.

Steady as she goes. Telecom is a steady sector that is not extremely volatile, O'Hare says. "If you get into a period of concern that the bull market is over or due for a good-sized correction, this should be a sector that should show relative outperformance," O'Hare says.



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