Should you buy Telstra stock on a pullback?

Is this telco a buy for value hunters?

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Telstra Group Ltd (ASX: TLS) stock has suffered a sizeable fall in the past year, down by around 15%, as the chart below shows.

By comparison, the S&P/ASX 200 Index (ASX: XJO) is trading close to all-time highs after rising 8% over the past year. Yes, Telstra shares have significantly underperformed, but I think this means the market is now undervaluing its prospects.

Let's take a closer look at whether Telstra stock is an appealing investment at today's prices.

Telstra stock valuation

One of the most popular metrics for judging the value of a business is profit.

I like to consider profit in earnings per share (EPS) terms rather than net profit after tax (NPAT) because I feel EPS is more relevant for investors given it's measured in per-share terms.

Commsec estimates forecast Telstra to make EPS of 18.1 cents in FY24, 19.5 cents in FY25 and 21.8 cents in FY26, suggesting Telstra's profit is forecast to be going in the right direction.

The current Telstra share price is valued at 20x FY24's estimated earnings and 17x FY26's estimated earnings.

I think these are very reasonable numbers, particularly for such a defensive ASX share. Most households and businesses use (and need) phones and an internet connection, ensuring ongoing demand for Telstra's services – it's not likely to see any major revenue volatility. And broadly speaking, investors are usually willing to pay a higher earnings multiple for a business if the profit seems resilient.

Growth metrics are going the right way

Generally, I only like to invest in businesses if they have compelling long-term outlooks. After all, if profit isn't growing, it's unlikely a company's share price and dividends can sustainably grow either.

In my opinion, there are a couple of important metrics that can help drive Telstra's profit growth.

Mobile subscriber growth is a very useful part of the company's success. Australia's ongoing population growth is helping increase the number of people needing a mobile service. As the business with the biggest and arguably best mobile network, Telstra is attracting a steady stream of new subscribers.

Over the 12 months to 31 December 2023, Telstra saw an increase of 625,000 mobile services in operation, which represented a 4.6% year-over-year increase.

How much subscribers pay for their subscriptions can also impact earnings, measured with the average revenue per user (ARPU) metric. The HY24 period saw Telstra's ARPU increase by 3.4%, excluding a prepaid one-off from product migration (ARPU was 2.1% growth year over year including the one-off).

These two metrics helped Telstra's overall HY24 earnings before interest and tax (EBIT) increase by 10.8% to $1.6 billion, while the net profit after tax (NPAT) went up by 11.5% to $0.9 billion, and EPS grew 12% to 8.4 cents.

Telstra's T25 strategy aims to increase its underlying EPS at a compound annual growth rate (CAGR) in the "high teens" to FY25. If the company achieves this goal, I think it will boost shareholder returns (via both the dividend and share price).

My verdict on Telstra stock

With a grossed-up dividend yield of 7% and the huge ongoing growth in demand for data, I think Telstra has a very promising future as a defensive play. The low Telstra share price in May hasn't been seen since 2021. I'd call the telco a compelling buy right now based on its strong market position and the positive outlook for earnings.

Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has positions in and has recommended Telstra Group. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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