AT&T (T) is a leading provider of communications and digital entertainment services in the U.S. and the world, offering internet access, TV and wireless service.

AT&T has dramatically underperformed S&P in the last five years, as it has lost 10% whereas the index has rallied 65%. The company has hardly grown its organic revenues while the market is also concerned that the market cap of $236 B will inhibit the company from growing at an attractive pace.

In Q1, AT&T missed the analysts’ estimates on both lines and thus disappointed the market. Its adjusted revenue decreased 1%, as its growth in wireless equipment and strategic business services was more than offset by declines in wireline services and domestic video. Nevertheless, the company managed to grow its earnings per share by 15%, partly thanks to the addition of 300K new DirecTV Now subscribers.

While AT&T has not lit up the market with its performance over the last several years, this has caused it to become undervalued.  Its undervalution in turn has boosted AT&T's dividend yield to greater than 6%.  AT&T is likely the single safest one of the few S&P 500 constituents with a yield north of 6% today.

Acquisition of Warner Media

AT&T recently completed the acquisition of Warner Media. The latter is growing its earnings at a high single-digit pace while it also has much higher free cash flow margins that AT&T. Furthermore, AT&T expects to achieve annual cost synergies of $1.5 B by the end of 2020 thanks to this acquisition. Overall, the acquisition of Warner Media is likely to reignite growth in the parent company and make it easier to somewhat accelerate dividend growth in the upcoming years. Thanks to low single-digit revenue growth and margin expansion from synergies, we expect AT&T to grow its earnings per share by about 6.4% per year on average over the next five years.

Dividend

The vast underperformance of AT&T has sent the stock towards its 6-year lows. This is in sharp contrast to the S&P, which is trading near its all-time high, after a 9-year bull market. As AT&T is trading around its 6-year lows, it is currently offering a 6-year high dividend yield of 6.2%. In addition, the stock is a dividend aristocrat, as it has raised its dividend for 32 consecutive years. Therefore, investors are now given the rare chance to purchase AT&T at a 6-year high dividend yield of 6.2% while they can also rest assured that the dividend will continue to increase for the foreseeable future, given the healthy payout ratio of 58% and the dividend record of the company.

Valuation & expected returns

AT&T is trading at a price-to-earnings ratio of 9.3, which is much lower than its historical average of 13.4. In fact, its current valuation level is the cheapest in the last decade. As its recent acquisition of Warner Media is likely to reignite growth, it is only natural to expect the stock to revert towards its average valuation level. If this occurs within the next five years, the stock will enjoy a 7.8% annualized gain thanks to the expansion of its price-to-earnings ratio.

Overall, AT&T can offer a 20.4% average annual return over the next five years thanks to 6.4% annual earnings-per-share growth, its 6.2% dividend and a 7.8% annualized expansion of its price-to-earnings ratio. As the stock is trading around its 6-year lows, it currently offers a combination of deep value, growth prospects and a 6-year high yield to compensate the investors who wait for the growth prospects to materialize.