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BT’s (LSE: BT.A) share price has dipped 15% from its 25 July one-year traded high of £2.23.
This does not necessarily mean that it is cheap at this price. It could be that the fundamental business is simply worth less than it was before.
But it could mean that there is indeed a bargain to be had here. And the gain could be much bigger than the 15% loss the stock has made over the past two months.
This depends on the difference between a share’s price and its value. The former is whatever price the market will support at any point. The latter reflects the true worth of the underlying business.
The gap between the two elements in any stock is where big long-term profits are made, in my experience. This is because asset prices tend to converge to their true value over time.
And my experience consists of several years as a senior investment bank trader and 30 years as a private investor.
What’s the fair value of this telecoms giant?
The discounted cash flow (DCF) model is by far the best method I have found of determining any stock’s fair value.
It pinpoints the price at which any share should trade, derived from cash flow forecasts for the underlying business.
This also makes it a standalone valuation. This means it benefits from being unaffected by under- or over-valuations across any business sector as a whole.
The DCF for BT shows its shares are a whopping 69% undervalued at their current £1.90 price.
Therefore, their fair value is £6.13.
Secondary confirmations of this bargain-level undervaluation also come from comparisons of key measurements with its peers.
For instance, BT’s 0.9 price-to-sales ratio is second-lowest among this group, which averages 1.4. These firms comprise Vodafone at 0.6, Orange at 1, Deutsche Telekom at 1.1, and Telenor at 2.8. So, BT is a bargain on this basis.
It is also cheap at its 18.2 price-to-earnings ratio compared to its competitor’s average of 24.4.
And the same is true of its 1.5 price-to-book ratio against its peers’ average of 1.9.
How are the underlying business prospects?
The driving force behind any firm’s stock price and dividend is growth in its earnings (or ‘profits’).
A risk to BT’s is the high degree of competition in its sector that could reduce its profit margins.
However, consensus analysts’ forecasts are that its earnings will grow by 13% a year to end-fiscal-year 2027/28.
These projections look well-founded to me, given BT’s recent run of results.
For example, its Q1 results released on 24 July saw profit after tax soar 23% year on year to £1.054bn. Meanwhile, earnings per share climbed 24% to 10.8p.
Its full-fiscal-year 2024/25 numbers released on 22 May showed a 12% year-on-year jump in profit before tax. Earnings per share soared 24% over the period. And cash flow from operating activities increased 17% to £7bn – this in itself can be a major driver for growth.
My investment view
I already have shares in BT and have increased my holding a couple of times already in the last year.
However, I will buy more soon based on its strong earnings growth.
This increase should push the stock further towards its fair value, from a bargain-basement starting point.
This story originally appeared on Motley Fool
