The Vodafone share price has increased in value substantially over the past 12 months, but its performance over the long term is much worse. Indeed, over the past five years, the value of the stock has fallen by 40%.
Past performance should never be used as a guide to future potential. What’s more, just because the Vodafone share price looks cheap today compared to its past trading history doesn’t necessarily mean the stock is cheap.
Still, when I look at the company’s fundamentals, I think the business is incredibly undervalued at current levels.
The best way to value a telecommunications business is to look at its free cash flow. This gives us an idea of how much money the group generates from its operations after deducting capital spending. By comparison, profitability can be misleading because it doesn’t include money spent maintaining telecommunications equipment, although it does include depreciation.
Vodafone is currently selling at a price-to-free-cash-flow ratio of 4.6. By comparison, the median valuation of telecommunications companies listed in the UK is 7. But Vodafone isn’t just a UK business. It has large international operations in Europe and Africa.
As such, it makes sense to look at the valuations of its overseas peers. In Europe, the industry median price-to-free-cash-flow ratio is 6.7. The ratio of the company’s largest African peer, MTN Group, is 14.
All of these figures suggest to me that the Vodafone share price is currently undervalued. It looks cheap compared to its peers in the UK and abroad.
As well as the company’s low valuation, it also appears to support an attractive dividend yield of 5.8%. This yield is based on City forecasts and is by no means guaranteed. Nevertheless, I think it shows the organisation’s potential.
Vodafone share price risks
Shares in the telecommunications giant appear cheap, but some investors might argue the stock is cheap for a reason.
The organisation has a high level of debt and has to spend billions on spectrum rights to guarantee its positions in existing markets. These are the most significant risks to the company’s growth. It’s also facing heavy competition in some of its best growth markets, including Europe and India.
The battle in India is so aggressive that the group has had to write down the value of its subsidiary there to zero. This shows just how much of an impact these contests for users could have on the firm. In the worst-case scenario, they could bankrupt the enterprise.
However, I don’t think these challenges justify the 30%-or-so discount the Vodafone share price is currently trading at compared to the broader telecommunication sector.
On that basis, I’d buy Vodafone for my portfolio today.
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Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.