This Telecom stock just declared a massive dividend increase. Should you buy?

Typically, a dividend increase from a large-cap stock is not very massive. Such companies typically have a lot of shares outstanding, so even a modest increase in shareholder payouts could mean additional expenses of millions, possibly even billions of dollars. So for the most part, whenever one of these titans declares a dividend increase, it’s more of a bang than a jump.

This was certainly not the case with telecom T-Mobile USA (TMUS -0.13%) earlier this month when it passed a 35% dividend hike. This is a pretty generous hike; let’s take a closer look at it and see if it helps to buy the stock.

Improved results and a FCF advantage

In mid-September, T-Mobile’s board of directors said its upcoming quarterly dividend would be $0.88 per share. This was certainly pleasing to shareholders who previously earned a payout of “only” $0.65. For investors who like to take advantage of such situations, there is still plenty of time to take advantage of this dividend hike, as it will be paid on December 12th to investors of record since November 27th.

T-Mobile is probably feeling flush because its cash flow is flowing strong. Scrolling through the second quarter earnings release from the end of July, one line item stands out strongly — non-GAAP (adjusted) free cash flow (FCF). At $4.4 billion, this was up 54% year over year and an all-time high for the company. Other financials rose nicely but not as steeply, with its core services revenue up 4% to $16.4 billion and overall net income up 32% to $2.9 billions of dollars.

FCF growth is the driver behind dividend growth, hence the company’s confidence in increasing payouts by more than a third. T-Mobile actually had quite a bit of gas in the tank for raises even before second-quarter FCF came in, as quarterly spending on several rounds of dividends — it didn’t initiate payment until late 2023 — was the much 769 million dollars.

Fortunately for the company’s shareholders, management has raised its FCF guidance for the full year 2024. This should help management achieve its annual dividend growth target of around 10%.

Playing catch up

T-Mobile management may feel it is in recovery mode. After all, the two rivals he’s always compared to — Verizon Communications and AT&T — have been steady and reliable dividend payers for years. Not only that, but the pair long ago wandered into high-yielding dividend territory and have remained there (despite significant changes in corporate structure, as with AT&T). Verizon keeps investors sweet with a payout of more than 6%, while AT&T isn’t far behind at 5.1%.

While T-Mobile’s 35% growth is impressive on many levels, even at the new improved level, its distribution would yield just 1.7%.

But we can expect that yield gap to close soon, assuming T-Mobile keeps roaring. A look at its cash dividend payout ratio — that’s the percentage of FCF it allocates to those dividend payments — reveals a figure considerably lower than that of AT&T or (especially) Verizon:

VZ Cash Dividend Payout Rate data by YCharts

Meanwhile, in next-generation mobile technology, T-Mobile is better positioned than its two peers. It has managed to build its 5G infrastructure to the point where it is a leader; according to a July analysis by telecom researcher OpenSignal, the company is “untouchable” for 5G availability, with subscribers to T-Mobile’s 5G service connected to the technology nearly 68 percent of the time they’re online. That percentage is nearly six times that of AT&T and about nine times that of Verizon.

In fact, of the 15 categories tracked by OpenSignal, T-Mobile took gold in nine of them, including 5G coverage experience and consistency of quality.

AT&T and Verizon are clearly committed to closing these gaps, but 5G isn’t cheap or easy to develop. AT&T plans to spend between $11.5 billion and $12.5 billion in the second half of this year on capital expenditures, and you can bet a lot of that is being poured into 5G. During the same period last year, AT&T’s expenses totaled $11.2 billion. Verizon is also spending more, at $8.9 billion to $9.4 billion, up from $8.7 billion in the second half of 2023. Is it any wonder the two are heavily indebted?

Make no mistake, T-Mobile has to spend to win, too, but its burden isn’t nearly as onerous. The company expects investments in the second half of the year to reach $4.2 billion, up from $4 billion in the year-ago period.

So, in short, T-Mobile operates in a business that many consumers consider indispensable, is effectively improving its fundamentals without being as burdened by spending targets as others, and has a dividend with room to grow rates inspiring. All of this makes his stock pretty compelling, in my opinion.