Is the TPG Telecom Ltd share price overvalued?

The share price of TPG Telecom Ltd (ASX: TPM) has risen over 10% this year, outperforming the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO), which languishes behind on a decline of just less than 2%.

This now means that the burgeoning telco’s shares are trading at a massive 29x trailing earnings, compared to industry rival Telstra Corporation Ltd (ASX: TLS) which trades at just just under 16x earnings.

So why are the shares trading at such a premium? The answer is growth.

I think Telstra is a great company and still a good investment, but its growth levels are nothing in comparison to TPG Telecom. According to CommSec, analysts are expecting Telstra to grow its earnings by just 1.6% per annum for the next couple of years.

TPG Telecom on the other hand is expected to grow its earnings by a huge 28% per annum for the same period. Looking at these levels it is easy to see why there is a disparity in what investors are prepared to pay to own both company’s shares.

Thanks to its acquisition of iiNet, I believe that TPG Telecom can produce earnings growth of this level. There is a huge growth opportunity for the company in mobile phones, where Telstra is by far the dominant player.

Currently TPG Telecom has just 473,000 mobile subscribers, compared to Telstra’s huge 16.7 million subscribers. Even Amaysim Australia Ltd (ASX: AYS) has 60% more subscribers with a very respectable 764,000.

But with Telstra’s service drop outs and public image taking a bit of a battering recently, I would not be surprised to learn that consumers have switched to competitors such as TPG Telecom. This could be a great boost to the bottom line, fuelling further share price gains.

Although I would say the shares are about fair value now, I would still expect them to provide investors with market-beating returns over the next couple of years if earnings come in strong.

It is worth remembering that there are risks when investing in growth shares. With the share price trading at such a premium, it does mean that it could come crashing down if the level of growth the company does produce doesn’t match the market’s expectations.

Thankfully I believe the top class management team and the quality of its brands and products should enable TPG Telecom to live up to expectations and provide strong returns to shareholders.

Foolish takeaway

Whilst TPG Telecom may look expensive, if it produces the earnings growth levels expected of it then I believe the current share price is good value.

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Motley Fool contributor James Mickleboro has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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