BT (LSE: BT.A) shares have dropped around 8% from their 25 June 12-month traded high of £1.45.
As a share’s yield rises when its price falls, its dividend payout has been boosted to 6%. This compares to the current average FTSE 100 yield of 3.6% and the FTSE 250’s 3.3%.
The share price dip also adds to the extreme undervaluation of the stock that existed before, in my view. This means to me there is less chance of any dividend gains being erased by an extended share price fall.
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How undervalued are the shares?
The telecommunications giant currently trades on the key price-to-earnings (P/E) stock valuation measure at just 15.8.
This looks cheap compared to the present P/E average of its competitors of 19.7. The group consists of Orange at 13.5, Vodafone at 18.7, Telenor at 19.7, and Deutsche Telekom at 27.
The same can be said for another principal stock valuation measurement I look at – the price-to-book ratio (P/B). On this, BT trades at only 1.1 against a peer group average of 1.5.
So how much of a bargain is it? To find out, I used a discounted cash flow analysis using several other analysts’ figures as well as my own.
This shows BT shares to be a spectacular 75% undervalued at their current price of £1.33. Therefore, the fair value would be £5.32 a share.
They may go lower, or higher, than that, of course. But it underlines to me how extremely undervalued the stock looks.
Does the growth outlook support this view?
Share prices and dividend payments are powered by earnings over time, and this is subject to risks for each company.
A key one for BT is the high degree of competition in its sector. Given the complexity of the telecommunications infrastructure involved in its business, any fundamental technical glitch is also a risk.
That said, analysts forecast that its earnings will rise by 11.9% every year to the end of 2026. Earnings per share are expected to grow by 11.6% a year to that point. And return on equity is forecast to be 11.9% by that time.
BT remains on track to deliver free cash flow targets over the next five years, according to its Q2 2024 trading update. It expects around £2bn by 2027 and about £3bn by 2030, which would be strong drivers for further growth.
Strong passive income flows
Last year, BT paid a dividend of 8p a share, giving a current yield of 6%.
So, £17,000 (the average amount in a UK savings account) invested in the shares would make an extra £13,930 after 10 years. This is if the dividends paid are used to buy more BT shares — known as ‘dividend compounding’.
After 30 years on this basis, an additional £85,384 would have been generated.
The total BT investment by then would be worth £102,384, which would pay £6,143 each year in dividend income!
I think BT shares are likely to increase dramatically in price in the coming years, driven by strong growth. This will also power dividend payments much higher over time, in my view.
Consequently, I will buy the stock in the next few trading days.
