Stocks: The Trouble with Telecom

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Even optimistic telecom shareholders like Smith don't expect explosive revenue and profit growth in the future. But, Smith says, firms can save money as the cost of technology falls and capital expenditures decrease. "Their costs are growing more slowly than their revenues are growing," he says.

These telecom firms "have a long history of driving costs out of the business," says Altman, who also owns AT&T and Verizon.

But Collins Stewart's Miller warns that telecom firms are still "highly deflationary businesses." In other words, falling customer prices are expected to cause the sector to grow more slowly than inflation over the long term.

Dividend Appeal

What still makes telecom attractive to some investors are the sector's dividends. Dan Genter, president of RNC Genter, is only holding telecom stocks in his firm's "high dividend strategy."

He doubts 2010 will be a "stratospheric year" for stocks, so with telecom, he says, "you get a good dividend while you wait."

Telecom firms currently have the four highest dividend yields in the S&P 500: Frontier Communications (FTR), with a yield of 12.5%; Windstream (WIN), with a yield of 9.9%; Qwest Communications (Q), with a yield of 8.3%; and Centurytel (CTL), with a yield of 7.8%.

The high yields of those smaller players may reflect their higher risk profile. But Verizon has a dividend yield of 5.9% and AT&T has a dividend yield of 6%, and most observers say those dividends look quite safe. The yield on the S&P 500 is 1.96%.

In fact, both firms have consistently raised their dividends. After meeting with Verizon management, JPMorgan (JPM) analyst Mike McCormack told investors Dec. 1: "The company remains committed to return free cash via dividends with a hope for continued annual increases."

In an environment where rates on money-market funds and short-term Treasuries are near zero, telecom stocks offer rare chances to get yield.

What they don't offer investors is a clear path to major price appreciation. It's possible that expectations are so low that telecom can surprise Wall Street with major profit or sales growth in 2010. But unless that happens, the sector may only return to fashion when investors again choose stability and consistency over the potential for major upside.

Steverman is a reporter for BusinessWeek's Investing channel.

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