It's often very hard to know if a sector is trading cheaply or whether this is the new normal. Just look at what happened to the mining & resources sector over the last 12 months to see how quickly market sentiment can change.
The telecommunications industry as a whole is significantly cheaper than it was eight months ago. Is now is the time to buy these two telco giants?
Telstra Corporation Ltd (ASX: TLS)
Telstra is the generous dividend payer that everyone knows and loves. However, I think it's being too generous now. In its half-year report to 31 December 2016 it disclosed that its dividend payout ratio is now 105%. It's paying out more in dividends than it earns in net profit, which is unsustainable over a long period.
There is a lot to like about Telstra. It has a market-leading mobile network business which is still growing the number of its customers. It has several small, but growing segments to its business such as e-health and the Internet of Things. It's receiving large NBN payments for its old copper network.
However, there are problems too. It will be spending a lot of money on upgrading and maintaining its network in upcoming years, which will hit the profit. It's losing its profitable fixed line earnings that are being replaced by lower margin NBN customers. It has an unsustainably high payout ratio.
The Telstra share price is now 18.5% cheaper than it was eight months ago and the grossed-up dividend yield is almost 10%. Assuming Telstra cuts its dividend by between 10% to 20%, investors could still receive a yield of around 8%. Not bad, but investors shouldn't expect much capital growth.
Telstra is currently trading at 14x FY17's estimated earnings.
TPG Telecom Ltd (ASX: TPG)
TPG has been great for investors who have held over the last five years, the share price has grown by over 287%. However, over the last eight months the share price has actually declined by 47%.
The market decided TPG wasn't worth as much because there were no more targets TPG could acquire, TPG grew its business substantially when it purchased iiNet in 2015.
TPG is seen as the low-cost provider of the major telcos and iiNet is rated as having the best customer service. I think TPG is in a better position to grow NBN market share than Telstra.
TPG is expanding into the Singapore mobile market after it recently won a mobile spectrum auction which could boost earnings in the years to come.
It's currently trading at 14.3x FY17's estimated earnings with a grossed-up dividend yield of 3.3%.
Foolish takeaway
Both businesses are trading at much more attractive values. For investors purely looking for dividend income, Telstra is currently paying bigger dividends. However, I think TPG will provide investors with a bigger total shareholder return over the years ahead at the current price.
However, if telecommunications stocks aren't your thing, then these three stocks should be great choices instead.
