Telstra Corporation Ltd (ASX: TLS) has proven to be stellar investment over the past five years, with its share price more than doubling and shareholders receiving a further 90% in fully franked dividends.
The broader S&P/ASX200 (Index: ^AXJO) (ASX: XJO), meanwhile, has risen just 20%.
Whilst the culmination of a revitalised brand and stronger operating performance have coincided nicely with falling interest rates (fuelling demand for big dividend stocks), could Telstra's valuation have finally gotten ahead of itself?
The balance sheet
Telstra's balance sheet is robust. Its enviable cash flows (a result of its superior product offering) enable it to take on large amounts of debt at a great margin and improve shareholder returns dramatically. It also has billions of dollars in cash.
Whilst its low-cost leverage enables stock analysts to justify bullish 12-month 'price targets', long-term investors need to remember that interest rates won't always trend downwards.
Growth
With the National Broadband Network slowly being rolled out across the country, Telstra's focus has shifted away from leveraging big profit margins on its 100-year-old copper cable network, to Asia. Whilst the full benefits from its international expansion may be a few years away, it's been making the right moves so far.
Autohome – Telstra's New York-listed subsidiary engaged in automotive advertising in China – has been performing strongly since its IPO a little over a year ago.
Telstra's partnership with existing telecommunications carriers and investment in data centres, subsea cables and related infrastructure also bodes well for future returns.
However, with Telstra's shares currently trading at 18x profits, investors must be prepared to hold the stock for the long term (five years at a minimum) because management are currently forecasting broadly flat EBITDA (earnings before interest, tax, depreciation and amortisation) growth in the short term.
Buy, Hold or Sell?
Telstra remains the most dominant local telecommunications company, has a reliable dividend yield (currently 4.8% fully franked) and its international expansion affords it healthy long-term growth prospects. However the question every investor must ask themselves before buying any stock is whether, or not, they believe it has a strong chance of market-beating returns.
With today's valuation, combined with the forecasts for medium-term profit growth, I think Telstra will struggle to achieve market-beating returns. However, I wouldn't advise investors rush out to sell their holding, because it has bright long-term prospects. Instead, I'd wait for Telstra's share price to drop back towards $5.00 before purchasing shares.
