Vodafone’s (LSE: VOD) share price is trading very close to its 28 August one-year traded high of 89p. This follows a 40% gain from its 12-month traded low of 62p seen on 9 April.
Regardless of this, there may may still be enormous value left in the stock. This is because a share’s price and its value are not the same thing.
The former is whatever the market is willing to pay at any given time. But the latter reflects underlying business fundamentals.
So, my starting point in looking at any growth share is not to focus on its price. Rather, it is to ascertain its fair value.
What’s the stock’s fair value?
Many investors try to establish a share’s value by looking at popular ratios, such as price-to-earnings.
The major flaw I have found with these are that they are comparative measures only. So, a stock could look undervalued compared to its competitors on these measures but still be fundamentally overvalued.
There is a growing awareness among investors that this could be true in the artificial intelligence stock sector, for example. I saw the disastrous effects of comparative valuation methods during the ‘dotcom bubble’ in the mid-1990s.
Instead, my experience has shown me that the best way to ascertain any stock’s fair value is the discounted cash flow method.
Crucially, this is a standalone valuation, so not prone to distortions across a sector. Rather, it pinpoints the price where any stock should trade, based on cash flow forecasts for the underlying business.
Within these cash flow forecasts are factored a firm’s earnings (or ‘profits’) growth. And this is the key driver to any company’s share price (and dividends, if applicable) over time.
In Vodafone’s case, the DCF shows its shares are 59% undervalued at their current 87p price.
Therefore, the fair value of the stock is £2.13.
What about projected earnings growth?
A risk to Vodafone’s earnings is the high degree of competition in the mobile telecommunications sector.
However, analysts forecast that its earnings will increase by a whopping 59% a year to end-fiscal year 2027/28.
Recent results were solid enough, in my view. In Q1 fiscal-year 2025/26, total revenue rose 3.9% year on year to €9.4bn (£8.16bn) while service revenue increased 5.3% to €7.9bn.
Service revenue is the income from the telecommunications services it provides to its customers. Revenue is the company’s total income, including from the sale of phones and other devices.
That said, I expect a big boost to earnings to come from Vodafone’s merger with Three. The new ‘VodafoneThree’ entity started operating on 1 June.
A day after, the parent companies (Vodafone and CK Hutchison Group Telecom Holdings) announced a £1.3bn investment in VodafoneThree’s network in the first year.
The aim is to secure the market leadership position in the UK over EE and O2.
It was also announced that £11bn would be invested over 10 years to create Europe’s most advanced 5G network.
My investment view
I already have shares in BT, so to own another telecoms stock would unbalance my portfolio.
However, I think Vodafone is well worth the attention of other investors who do not have the same problem.
