Do the Commonwealth Bank of Australia (ASX: CBA) share price and Telstra Corporation Ltd (ASX: TLS) share price offer a margin of safety or are they overvalued?
Margin of Safety
In investing, it's important to know the difference between price and value.
For example, if you are choosing between a $10 Kmart t-shirt and a $100 Hugo Boss t-shirt, typically, you don't make the decision based on price — it's one of value.
Some vain people might buy the $100 t-shirt because it has a higher price, but — subconsciously — that only emphasises the point that the decision is based on value — not price. Overdressed they may be, but they value the idea of having the highest priced t-shirt at the Sunday BBQ.
The same concept can be applied to analysts in the sharemarket. They run models to try and predict a company's future sales and profit, then recommend shares if they believe the value of the shares is less than the price. That difference is called a margin of safety.
However, as quick as Hugo Boss fashion comes and goes, so too can the value of a company's shares. Worse still, everyone values things differently.
For example, I might say Telstra's broadband service is going to be a big loser from the NBN rollout whereas you might say Telstra's bundled services will help it win market share.
On the other hand, one analyst might say that Australia's housing market is overvalued; therefore, the Commonwealth Bank of Australia share price is too high.
Valuations — and therefore margins of safety — are built on opinion.
Are these 2 blue chip shares overpriced?
In my opinion, Commonwealth Bank of Australia shares appear a little expensive at today's prices. However, I do not think it is a sell right now because I believe it will be a bigger and more profitable company in five years — regardless of what its share price does. Moreover, if I had made a lot of money on the investment I'd value not having to pay capital gains tax and the half-yearly dividends. I'd say it is a hold at today's prices.
Getting a handle of Telstra's valuation is a little more tricky in my opinion. Potentially, we are entering a period in which Telstra's existing assets like broadband will fall to the wayside. However, I also think its mobiles business will be stronger five years from now. Call me greedy but despite it's recent fall I'd rather wait for a lower price before buying Telstra shares. A lower price maximises the margin of safety — the chance your valuation is wrong.
