Ask Matt: Is AT&T a good stock buy?

ByABC News
June 12, 2012, 8:48 PM

— -- Q: What do you think of AT&T stock?

In an age where people rely on telecommunications to help them do everything from read the news to navigate the freeways, AT&T is certainly well positioned. The company is one of the leading providers of both wired and mobile telecommunication services to consumers and businesses.

But while telecommunication services are arguably more important than ever, AT&T's stock is far from its peaks hit in the late 1990s and early 2000s. Shares of AT&T hit $58 in October 2000, as the dot-com and tech boom was fading. Shares are now down 40% from those heights, hardly the reaction investors should have anticipated when they jumped on the bandwagon in 2000.

That's all ancient history in the telecom world, though. What about investing in AT&T based on the company's situation now? Is AT&T poised to capitalize on the world's seemingly insatiable demand for connectivity?

To find out if AT&T is a good investment, we'll put the stock through the four tests considered at Ask Matt, including:

Step 1: Risk vs. reward. When you take a risk on a stock, you want to make sure you're properly rewarded. Downloading AT&T's trading history back to 1984, we see the company generated an average annual compound return of 11.5%. You can then add the current annual dividend yield of 5.3% to arrive at a potential 16.8% expected return. That's a tremendous performance if you consider the S&P 500 returned an annualized 10.7% return over the same period, says IFA.com.

But to get that better-than-average return, you had to take greater risk. You accepted risk — standard deviation — of 21.4 percentage points. So, by investing in AT&T, you took on 37% more risk to get a 57% greater return. This is huge. AT&T is one of the very few individual stocks to pass this test by generating an excess return that's greater than the added risk. It's just one thing for investors, though, to consider.

Step 2: Measure the stock's discounted cash flow. Some investors decide whether a stock is pricey by comparing its current price to the present value of its expected cash flows. It's a complicated analysis made simple with a system from NewConstructs.

When we run AT&T's stock, we find it's rated "dangerous." In other words, the current stock price is well above the value of what the company is expected to generate in cash over its lifetime. AT&T fails this test, and that indicates the stock is very overvalued.

Step 3: Compare the stock's current valuation to its historical range. BetterInvesting's Stock Selection Guide can help. Even if the company can increase earnings 4% a year the next five years, that would put the stock in the "sell" range. This indicates AT&T's stock is pricey relative to the earnings the company is expected to generate.

Step 4: Check the company's financial health. Before investing in any company, you want to make sure it's in good financial shape. A quick way to check is to look at where it falls on the USA TODAY Stock Meter, which ranks stocks from conservative (1) to aggressive (5). AT&T scores an acceptable 2.8 here. You can get a Stock Meter score for almost any stock by going to money.usatoday.com and putting the stock's ticker symbol or company name into the Get a Quote box.