I've compiled a list of three ASX-listed companies, which I have calculated to be undervalued. My calculations are based on the method outlined in Roger Montgomery's book Value.able. This method is not overly complex, but I still believe it provides a good understanding of value.
How do you calculate a company's value on the ASX?
For my calculations, I have used each company's historical rate of return on equity and an investor required rate of return of 10%. Together, these figures have been used to create two 'multipliers', one of which has been magnified to compensate for a company which retains its earnings. This is based on the theory that a company that can retain its earnings and put them to good use is worth more than a company that cannot. These two multipliers were then proportionally applied to the expected equity per share of each company, with the dividend pay-out ratio dictating these proportions.
The intrinsic value of a company is subjective and should not be the sole justification for an investment decision. That being said, if you like the future prospects of any of the below companies, now might be a good time to buy.
Three undervalued ASX-listed stocks
The Westpac Banking Corporation (ASX: WBC) share price currently sits at just over $28, which (based on past performances) constitutes a discount to intrinsic value. This price appears to indicate that the market does not expect the future of Westpac to be as bright as its past. Given the fallout from the Royal Commission, this is not an unreasonable view for the market to form. However, betting against one of the 'Big Four' banks also feels unconventional.
The Telstra Corporation Ltd (ASX: TLS) share price last closed at $3.86. Historical results tell us that this share price is good value. Telstra has been a dominant player in the Australian telecommunications industry for a long time and with the merger of TPG Telecom Ltd (ASX: TPM) and Vodafone Australia on hold, this could easily continue into the future.
The Lendlease Group (ASX: LLC) share price has fallen almost 40% in less than 12 months. Lendlease's most recent half-yearly results also showed a severe drop off in profit. Past results, however, indicate that at the current price of $13.43, Lendlease shares are a good buy. For this to remain true, the financial results of Lendlease must improve to mirror more closely what has been seen in the past.
Foolish takeaway
With an uncertain future there is no way to perfectly calculate the true value of any one company. However, attempting to do so using historical data can help an investor get a better understanding of what is a reasonable price to pay for a particular share.
As an investor, you might be willing to pay more or less than the historically calculated intrinsic value of a share depending on your own beliefs about the future prospects of a company. The current market price, however, should not be used as justification.
