easyJet’s (LSE: EZJ) share price had fallen 16% from its 12 December one-year traded high of £5.90.
This does not necessarily mean that it is now a bargain. It does not even necessarily mean it is more of a bargain now than it was before.
The reason why is that a stock’s price is a different measure to its value. Price is just the level the market is willing to pay at any given time. But value reflects the true worth of the underlying business.
So to ascertain whether it is, in fact, a bargain, I thoroughly examined the value proposition here.
Is there a price-to-value gap here?
The most effective method I have found to establish any stock’s fair value is discounted cash flow analysis. This identifies the price at which any stock should trade, derived from cash flow forecasts for the underlying business.
In easyJet’s case, it shows the shares are 55% undervalued at their current £4.68 price. Therefore, their fair value is £10.40.
This is an important number to note, as asset prices tend to converge to their fair value over time, in my experience. This consists of several years as a senior investment bank trader and decades as a private investor.
So why has the price dropped?
One recent negative factor for the price drop was the 16 September downgrade by US investment bank JP Morgan to Neutral from Overweight. This means the bank no longer expects it to outperform the sector, only to perform in line with it.
The primary reason for this move is the bank’s forecast for weaker pricing into the winter months. In my view, this is just one bank’s ratings action. And even if true, it is a very short-term factor, pertaining just to the coming months. Indeed, the bank went on to say that easyJet could still boost its medium-term earnings growth by increasing its holiday business.
Another negative factor has been Russian drone and aircraft incursions into NATO members’ airspace. If continued, this could cause changes to air travel routes that are longer and more expensive in terms of fuel costs. Again, I do not believe this will continue over the long term.
I believe a genuine risk over time is the intense competition in the sector that might reduce easyJet’s earnings.
My investment view
Aged over 50 now, I focus on stocks that generate a dividend yield of 7%+. This is because I want to increasingly live off this income while reducing my working commitments. easyJet’s dividend yield is currently 2.6%, so it is not for me on this basis.
However, if I were younger I would see the firm’s strong earnings growth prospects as a key reason to buy the stock.
More specifically, analysts forecast its earnings will increase by 10.8% a year to the end of 2027. And it is growth here that ultimately powers any firm’s stock price and dividends higher over the long term.
Given this, and the short-term factors that have pushed the share price down, I think easyJet is a classic short-term risk/long-term reward play.
