Telecoms companies make some of the best investments thanks to their defensive nature and preference to return the majority the cash generated from operations to shareholders.
However, not all companies in the telecoms sector are created equal, and some are better stewards of shareholder capital than others.
Sky’s the limit
When it comes to generating the best returns for shareholders, there are few companies that can match the record of Sky (LSE: SKY). Sky is the biggest pay-TV provider in the UK. The company’s size and dominance over the pay-TV market as well as access to bespoke programming gives it an edge over smaller peers. What’s more, customers acquire the company’s services on a 12-month contract, which gives the group visibility over earnings and cash flows.
All of the above factors mean that Sky can generate one of the best returns on invested capital employed (ROCE) in the media industry. A high double-digit ROCE often means that the company has a defensible edge versus its competitors and in the past, Sky’s ROCE has averaged 30%. As a result, over the past six years, Sky’s shareholder equity has risen fivefold.
Sky’s shares currently trade at a forward P/E of 15 which may seem expensive but is relatively cheap considering the company’s impressive returns on capital. The shares support a dividend yield of 3.7%.
Biggest rival
It would be fair to say that BT (LSE: BT.A) is Sky’s biggest rival in the UK. Just like Sky, BT has achieved impressive returns for investors over the years, and the company has recently been investing heavily in growth to help differentiate itself from the competition.
These investments seem to be paying off. Yesterday BT announced a record rise in pre-tax profit of 9%, showing that the company is moving in the right direction. BT also intends to invest £6bn in ultrafast broadband as it seeks to provide wider and faster coverage across the UK, further differentiating itself from peers.
On the valuation front, after recent gains BT is trading at a forward P/E of 14.6, and the shares support a yield of 3.5%.
Struggling
As BT and Sky have powered ahead over the past five years, Talktalk (LSE: TALK) has tried to keep up but the company has repeatedly stumbled and it now looks as if Talktalk’s growth story is starting to unravel.
Up until last year’s hacker attack, City analysts were expecting Talktalk’s earnings to double during 2016. However, now the City expects earnings to grow by a more modest 9%. Based on this forecast, Talktalk’s shares are trading at a forward P/E of 29 and support a dividend yield of 6%.
Unfortunately, while this yield may look attractive for income seekers, the payout of 16.2p is uncovered by Talktalk’s earnings per share of only 8.9p.
Foolish summary
Overall, it looks as if the telecoms stock to buy is Sky. BT looks like a solid hold as the company’s growth picks up, while Talktalk might be a sell as the company struggles to rebuild its reputation and return to growth.
