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At What Price Would Vodafone Group plc Be A Bargain Buy?

vodPatience is one of the key attributes of a successful investor. The likes of US master Warren Buffett have been known to wait years for the right company at the right price.

Now, while buying stocks at a fair price will tend to pay off over the long term, we all love to bag a real bargain.

Today, I’m going to tell you the price I believe would put Vodafone Group (LSE: VOD) (NASDAQ: VOD.US) in the bargain basement.

Old Vodafone/New Vodafone

Vodafone’s sale of its 45% stake in US phones firm Verizon Wireless (VZW) to Verizon Communications was a game-changer. The $130bn (£84bn) deal was announced in September last year, and completed in February this year.

Vodafone needs to replace the lost earnings from VZW, but this isn’t going to be achieved any time soon. As such, there is a dramatic difference in the valuation of ‘old’ Vodafone and ‘new’ Vodafone.

The table below shows analysts’ P/E and dividend yield 12-month forecasts on selective pre-deal and post-deal dates for which I still happen to have data.

  Share price P/E Dividend yield (%)
Today 206 31.3 5.6
July 2014 196 27.5 5.9
Feb 2014 VZW Deal Completed
Sep 2013 VZW Deal Announced
July 2013 188 11.5 5.5
April 2013 187 11.4 5.9

As you can see, the P/E has rocketed due to the loss of the future earnings contribution from VZW.

The market is demanding we pay a sky-high P/E of 31.3 for a company that’s on an acquisition spree to replace lost earnings, with all the risk that entails: overpaying for assets, unforeseen integration problems, and so on.

For Vodafone to trade today on the same kind of P/E as before the VZW sale, the share price would need to come down to 75p!

You can see, then, that there are real problems with trying to put a fair earnings multiple on Vodafone at this point in time.

Dividend

Taking dividend yield as a value marker, we can note that — in contrast to the P/E — Vodafone’s yield since the VZW sale is much the same as it was before. The difference is, though, that the forecast dividend (11.5p) is now uncovered by forecast earnings (6.55p).

Now, Vodafone has the resources to fund an uncovered dividend for awhile, but I’m going to value the company on the basis of a theoretical dividend covered by earnings (6.55p) and a market average forward yield (3.2%). That gets me to a fair-value share price pretty much bang in line with the current 206p.

But I want a bargain. So, I’m going to demand a discount of 25%, which gives me a share price of 155p. As it happens, that’s exactly the price at which I was highlighting Vodafone as a bargain for Fool readers back at the start of 2013.

A discount of 25% may be a little greedy, but deciding on a valuation and resisting the temptation to overpay can help investors like us target a million-pound portfolio.

The magic million isn't as far-fetched as it may sound. To find out why, help yourself to a FREE copy of the Motley Fool guide, "10 Steps To Making A Million In The Market".

This free report may transform your wealth -- simply click here for your copy.

G A Chester has no position in any shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.