Are these two telcos oversold?

Former market darlings TPG Telecom Ltd (ASX: TPM) and Vocus Communications Limited (ASX: VOC) have seen their share prices smashed in the last couple of months. Vocus is down over 40% since its high at the end of May and TPG is down 39% since the end of July.

However, despite these falls over a ten-year period both stocks have thumped the market. TPG is up 943% and Vocus is up 1,087%. So are the recent price falls a buying opportunity for the long-term investor?

Both companies have relied on acquisitions to deliver significant earnings growth over recent years. This strategy has now run its course as they have both now reached a size whereby there is a shortage of suitable targets.

However, prior to the recent price falls, both these companies had enterprise value-to-earnings multiples (EV/E) in the high twenties implying strong growth ahead. Given a main growth option is no longer available it seems justified that earnings multiples have contracted.

Furthermore, telecoms providers essentially sell a commodity. There has been a decades long period during which the industry has struggled to keep up with demand for data which has enabled the likes of TPG and Vocus to earn attractive profit margins. But will supply catch up to demand and put downward pressure on prices?

There is evidence of this in the consumer mobile market where cost per gigabyte of data has fallen heavily in the last couple of years. I do not know if pricing pressure will persist or if it will impact all parts of the industry but the way that TPG and Vocus were priced previously assumed they were price makers when in fact they are both price takers.

I’m unconvinced that Vocus and TPG are buys at current prices. To me, it looks like they were significantly overpriced before recent falls and perhaps now their prices better reflect reality.

Personally, I prefer Amaysim Australia Ltd (ASX: AYS) as an investment. As a purely online retailer, it has a low cost of doing business and earns high returns on equity because it does not build costly network infrastructure. It is also trading at a reasonable price relative to current annualised earnings.

Still, I would say that TPG and Vocus are both much better investments than any of these three rotten shares.

After a double-digit rally for the ASX since 2016 lows, investors should be on high alert. You'll find a full rundown below of 3 shares we think you should avoid today plus one top pick worth buying, even if the market turns south and the RBA keeps rates at an "emergency low." Simply click here to uncover these stocks.

Motley Fool contributor Matt Brazier 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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