The 5G stock that I’m buying for market-beating returns

Verizon’s 5G exposure means that I think that it has the potential to deliver a market-beating return on investment.

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The 5G revolution promises internet capacity at 100 times greater than before. This means new possibilities for businesses, lower lag times for gamers, and faster download times for the rest of us. The 5G stock that I’m buying to participate in this transition is Verizon (NYSE: VZ).

1. Verizon and 5G

There are immediately two concerns with Verizon as a 5G stock. First, Verizon is unlikely to be the biggest winner in the 5G revolution. Second, the company has had to make huge capital investments in order to build out the infrastructure for the 5G network. I think that each of these concerns can be met, though.

Overall, I think that Verizon’s limited upside is offset by a degree of predictability. My general view is that Verizon is easy to identify as a part of the infrastructure supporting 5G internet. By contrast, I find it hard to tell which company will provide the chips for smart devices or win the battle for gaming supremacy. So while Verizon is unlikely to see the biggest jump in earnings from the introduction of 5G, I think it comes with a predictability that I find attractive.

Verizon has taken on substantial debt to build out its 5G infrastructure, but I think that this is currently priced into the stock. Verizon stock currently has a market cap of $223bn. The company has around $10bn in cash, around $178bn in total debt, and produced just over $20bn in free cash in 2020. This gives a business return of just under 6%. As the debt decreases and the free cash flow increases, I expect this to grow over time, making this a good 5G stock for me to invest in. 

2. Market-beating returns

An investment in Verizon stock at the end of 2011 would have returned an average of 6.6% annually, including dividends. An investment into an S&P 500 index fund at the same time would have returned an average of 14.4% per year on the same basis. At the stock level, Verizon has clearly underperformed the broader index over the last decade or so. 

In order to evaluate an investment, however, Warren Buffett says that we should look to what the business itself produces. When we do this, I think that things look different in comparing Verizon to the S&P 500. Since the end of 2011, Verizon has grown its operating earnings by just under 150%. Operating earnings for the S&P 500, however, have only increased by around 66%.

The difference between the stock returns and the business returns is the result of a change in the multiple that investors are willing to pay to own each security. Unlike Verizon, the S&P 500 now trades at a significantly higher price-to-earnings (P/E) multiple to its 2011 levels. The S&P 500 traded at a P/E multiple of 12.5 in 2011 and trades at a P/E multiple of around 23 today. Verizon, on the other hand, used to trade at a P/E multiple of 18 and now trades at a multiple of just under 11. 

I think this means that, when we follow Buffett’s advice and look at what the underlying asset has produced over the last decade, we can see that Verizon has clearly outperformed the S&P 500. As a result, I think that Verizon’s lagging stock price presents an attractive investment opportunity to add a 5G stock to my portfolio.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Stephen Wright owns shares of Verizon. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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