Vodafone (LSE: VOD) (NASDAQ: VOD.US) is quite a different company from what it was a year ago. Having demerged its stake in US telecoms giant Verizon it has been on a shopping spree, buying telecoms and broadcasting assets around the globe and investing in high-speed data networks. Its aim is to be a one-stop shop offering pay-tv, fixed and mobile telecoms, broadband and entertainment content to millions of customers.
When is a company cheap, and when is it expensive?
The difficult thing is, once the dust has settled, finding a way of valuing Vodafone post-demerger. How can you work out when the company expensive, and when is it cheap?
We will only see how successful Vodafone’s strategic transformation has been once its acquisitions and investments have bedded in and are yielding profits.
It is only when the telecoms and broadcasting giant has spent its cash pot and the newly assembled orchestra is playing in complete harmony that we will see what the reshaped Vodafone is really like.
At the moment the company is cash-rich, but asset-poor. This means that we will see the company’s profitability tumble over the next couple of years or so. The simple numbers tell the story: the trailing P/E ratio is 12.5, whereas the forward P/E ratio is 17.
You need to look beyond next year’s results
But Vodafone is not a company in decline, but a company in the throes of dramatic change. I expect the profitability to increase strongly once all the acquisitions and investments have been made.
That’s why, when valuing Vodafone, I tend to focus on the trailing P/E ratio number. My expectation is that the P/E ratio at the current share price will eventually be around 12 or lower. After all, if the P/E ratio is higher than 12, then you’d have to conclude the strategic transformation has not been successful.
But I think the outlook is very positive and investors need to look beyond next year’s results.That’s why my view is that, after the recent share price falls, Vodafone is a bargain.