Verizon Valuation
Earlier this year I bought some shares of Verizon (VZ) because it seemed like a quality company that has heavily sold off, and offered a dividend yield over 7%. Now I want to revisit this company to learn more about why it has sold off and to what magnitude the stock is undervalued. In this post I want to do some back of the envelope calculations to estimate Verizon’s fair value stock price. The technique used to value Verizon is a simplified earnings power valuation from one of my favorite investing books.
Just for some context, Verizon is currently trading around $34 a share, with a market capitalization of $142B. The company has a low P/E ratio, at 6.8, and also has a high dividend yield at 7.9%. VZ has had a 52 week high stock price of $42.58, but traded around $55 in 2022, and $60 back in late 2020.
The first step is to get a reasonable estimate of revenue. Verizon’s revenue steadily grew until 2015, where it has since fluctuated around $130B. Last year, Verizon put in a new peak in revenue at $136.8B. For this analysis I’ll use $135B as a go-forward revenue figure.
Next, let’s take a look at Verizon’s operating margin. Over the past five years, 2018 had the lowest margin at 17.02% while 2021 had peak margins of 24.29%. Given this range, I’ll estimate operating margins to be 22%. Applying this to the $135B revenue estimate, we get an estimated operating income of $29.7B.
Last year, VZ paid about $3.6B in interest expense, so we will assume this will stay consistent. The income tax rate the VZ pays varies quite a bit, however it has been around 23% the last three years so I will use that figure. Applying the 23% tax rate to the after tax operating income produces an after tax profit of $20.1B
Next, I capitalize the after tax earnings to produce a fair value market capitalization of the equity. Verizon is currently issuing long term debt with rates around 3.5%. On the equity side, I look at historical P/E ratios. Over the past 5 years, Verizon’s average P/E ratio has been quite low, peaking in 2018 at 14. Another factor at play is that interest rates have risen to the point that short term bonds yield 5%, which means equity discount rates need to be increased. Based on these factors, I’ll use an 8% discount rate.
Dividing the estimated after tax profit of $20.1B by the 8% discount rate, we get an estimated equity value of $250B. Finally, we can divide the fair value equity value by the 4,213M shares outstanding, to arrive at a fair value stock price of $59. Verizon currently trades around $34 a share, which is a pretty large discount to the estimated value. As a reference, VZ peaked in price around $60 a share in 2020 and traded in the 50s during 2021.
Based on these rough calculations, Verizon seems quite undervalued. However more due diligence needs to be done to check all the assumptions I am making. The next steps are to read Verizon’s annual report to better understand their financials and further investigate why the market is so pessimistic on the company.