The CAPM Trade: Telecom Industry

Includes: S, T, TMUS, VZ
by: Erik Gholtoghian

CAPM is the most well respected model of valuation in financial theory. There are special derivatives of the theory, which use more factors, but the basic premise is the same: stocks behave in a relative fashion, regardless of the base value.

The most basic comparison is comparing a stock's relative risk to that of the market, and then comparing performance. The Capital Asset Pricing Model suggests that the expected return of a stock is based upon the beta of each company's stock. I ran a regression and calculated betas on all of the stocks in the telecom industry and created a CAPM valuation to show the prior one-month CAPM alpha value.

The results are very clear and show that MetroPCS (PCS) is offering compelling value versus the sector, potentially undervalued by as much as 17.3%. Sprint (NYSE:S) and Verizon (NYSE:VZ) still both offer acceptable value as well. AT&T (NYSE:T) on the other hand appears to be overvalued for the short-to-medium run.

On a more basic level, the results also show that the market is pricing MetroPCS with tremendous risk. I find this to be absurd as it offers less risk than really any of the other companies due to its market niche in low-end products.

(Click chart to expand)

ticker SPY PCS VZ S T
beta 1 1.56 0.85 0.56 0.47
one month return 10.88% -0.34% 1.96% -5.92% 3.92%
Expected return 16.95% 9.19% 6.09% 1.84%
one month alpha 17.29% 7.24% 12.01% -2.08%

Disclosure: I am long PCS.