Currently, Telstra Corporation Ltd (ASX: TLS) shares are offering a forecast dividend yield of 7.5% – fully franked, no less.
Telstra's dividend yield, calculated as dividends per share divided by its share price, has ballooned over the past year because its share price has tanked.
TLS share price
As can be seen, it's been a tough trot for Telstra's punters – it is down 29% in a year.
Is it time to top up on Telstra shares?
At any point, savvy investors look to exploit the difference between price and value. Sure, the dividend yield looks great but what's the point of buying Telstra shares for its 7.5% dividend if its share price falls 10%?
No-one can predict the future.
So the only way we can improve our chances of investing success is by building an understanding of the risks and rewards, then coming up with a value.
For example, Telstra's dominance in broadband and home phones is gone. TPG Telecom Ltd (ASX: TPM), Vocus Group Ltd (ASX: VOC), Optus and about 100 other brands on the NBN have and will continue to erode its fixed businesses.
In mobiles, Telstra still reigns supreme. But with Optus, Vodafone and TPG turning up the heat with new packages, it's doubtful that Telstra's profit margins will remain as high as they are.
Admittedly, people tend to stay with Telstra's mobiles for the slightly better coverage and reliability — even if it means paying an extra $200 per year.
But it often takes just one recession, a wages crisis or housing crash for people to wash out the overpriced items in their lives.
On the positive side, Telstra is a cash cow. From it current suite of businesses, it generates boatloads of cash flow.
What is it worth?
One way we can quickly value Telstra shares is by valuing its dividend payments. I showed in this article how it can be done in seconds using the Gordon Growth Model.
Note: this valuation should not be relied upon in isolation.
If Telstra's dividend remains flat at 31 cents per share, its valuation is $5.20. However, if its dividend falls to 28 cents next year then remains flat, its valuation falls to $4.71.
At $4.12, that's a healthy margin of safety. That is, the difference between price ($4.12) and value (somewhere between $4.71 and $5.20). Still, I would like a wider margin of safety given the risks.
Foolish Takeaway
Our dividend model suggests Telstra shares are worth more than $4.70. However, that's only one model, which should not be relied on in isolation. For example, what happens if Telstra scraps it dividends altogether (unlikely) to pay down its enormous pile of debt?
As I have said before, if Telstra shares fall below $4 per share I will start to get excited about taking a slice of this giant dividend share.
Until then…
