{"id":858,"date":"2011-03-31T09:18:10","date_gmt":"2011-03-31T07:18:10","guid":{"rendered":"http:\/\/www.invest-aura.com\/?p=858"},"modified":"2025-03-17T11:07:06","modified_gmt":"2025-03-17T09:07:06","slug":"are-vodafone-france-telecom-and-deutsche-telekom-stocks-underpriced","status":"publish","type":"post","link":"https:\/\/www.investaura.co\/wordpress\/2011\/03\/are-vodafone-france-telecom-and-deutsche-telekom-stocks-underpriced\/","title":{"rendered":"Are Vodafone, France Telecom and Deutsche Telekom stocks underpriced?"},"content":{"rendered":"

This article is the follow-up to a previous article entitled \u201eTime to dump your European service provider stocks?<\/a>\u201c<\/p>\n

Over the period 2004-2010, we have seen that a number of big European stocks have been down a bit or a lot<\/strong>. This includes three big names in the market:\u00a0 Vodafone, France Telecom (Orange) and Deutsche Telekom. If these stocks have gone down over the last 7 years, does that mean that they are underpriced now?<\/strong><\/p>\n

Those who believe that the market is fully efficient will say that this question is absurd because the market is always at the right price. But firstly, there is considerable amount of evidence that the market is not fully efficient. And secondly it can be very useful to better understand what you have to believe about the future for stocks to be priced at their current level. If your beliefs are not what the market believes, then there is an opportunity to put a bet on what’s going to happen in the years to come.<\/p>\n

How do you know whether a stock is underpriced for a start? If you have ever bought or sold stocks, we bet that in 95% of the cases you have not done any detailed analysis<\/strong> but relied on sentiment, gut feeling, what you read on the Internet or what your financial advisor has told you. But you should do the check yourself. This will take you a bit of time, but might avoid some costly mistakes. And in many cases, you will be surprised by the results. In all cases, you will learn something about the stocks that you contemplate buying or selling, and this is great news!<\/p>\n

There is a fundamental problem with stocks<\/strong>. Unlike other familiar products that you buy on a regular basis (say petrol for your car, airplane tickets for your holidays, or simply beer for the next grill party) we as human beings are not well equipped to know what the right price for a stock should be. If Vodafone sells at 2 Euro a share, is this cheap? What about France Telecom selling at 16 Euro per share, doesn’t that look expensive? Intuition does not help when we look at individual stock prices.\u00a0 But this does not get better if we look at market cap: is France Telecom at 42 billion Euros cheap?\u00a0 Is Vodafone at 104 bn Euros expensive? Looking at total enterprise value (EV) does not help either: France Telecom is at 74 bn Euros, Vodafone at 138 bn Euros.<\/p>\n

So we have to do a little more work. There are two broad methods to check the price of a stock: P\/E ratios as well as other multiples, and \u2018fair value\u2019 using discounted cashflow models of various sorts.<\/p>\n

P\/E ratios look easy, and that\u2019s why most people use them<\/strong>. But actually they are bloody complicated to use correctly, and that\u2019s why they can be so misleading.\u00a0 The idea of P\/E ratios is to compare the P\/E of a stock with its peers at the same point in time, or with historical averages for the stock or the industry. But P\/E ratios are massively distorted by gearing i.e. the way companies are financed (equity, debt), as well as accounting treatment (the way company depreciate their assets in particular).\u00a0 So comparison with peers can only be indicative as best. To get around these problems you should always use P\/Es in combination with a couple of other ratios, in particular price to sales and price to EBITDA, taking the entity value for price<\/strong> rather than stock price, because Sales and EBITDA relate to the total entity (they are pre-interest expenses so don’t take the financing structure of the firm into account).<\/p>\n

Another approach \u2013 not necessarily more complicated – is to try to figure out what the \u2018fair value\u2019 of a stock is.\u00a0A stock is underpriced if there is substantial deviation between its \u2018fair value\u2019 and its current market value<\/strong>. Note that this does not tell you whether the stock price will increase in the future or not. Stock prices are only determined by supply and demand, and demand could remain low for many years to come.\u00a0 After the 2001-2003 crash investors might have good reason to hate, or a least avoid, telecom stocks.\u00a0So as long as the majority of investors do not believe that the stocks are underpriced, they are unlikely to move up<\/strong>.<\/p>\n

Now, the market value of a stock is easy to find: check current price on the stock market.\u00a0 On 31 March 2011, these were: 177 pence (2.02 Euro) for Vodafone, 15.8 Euro for France Telecom and 10.90 Euro for Deutsche Telekom.<\/p>\n

To estimate fair value, we use a simple perpetuity valuation model<\/strong> that simply states that the Enterprise Value is related to NOPAT<\/em> (Net Operating Profit less Adjusted Tax), the perpetuity growth rate g<\/em>, the return on invested capital ROIC<\/em> and the company cost of capital WACC<\/em>.\u00a0 Note that the model assumed that profit margins, g, ROIC are constant in the future.\u00a0 The perpetuity formula is as follows:<\/p>\n

EV = NOPAT x (1-g\/ROIC) \/ (WACC-g)<\/p>\n

Remember that the entity value is also the sum of the equity value (market cap) and (net) debt value (EV=E+D).<\/p>\n

So you can now proceed as follows:<\/p>\n