Shares in investment manager M&G (LSE: MNG) generate one of the highest yields in any FTSE index – currently 9.4%. And they are down 13% from their 21 March 12-month traded high of £2.41.
Such a drop flags a potential bargain-basement buying opportunity for me to add to my existing stake in the firm. This would allow me to lower the average price of that holding. And a bigger stake would significantly increase the dividend income I could make from the shares.
Alternatively, the share price fall might indicate the company is fundamentally worth less than it was before.
Either way, some action on my holding is required so I ran the numbers to find out what that should be.
How does the core business look?
Earnings growth is essentially what drives a firm’s share price and dividend over time.
A risk to M&G’s is a resurgence in the cost-of-living crisis if inflation significantly picks up. This could cause customers to cut back on expenses, including policies with the firm.
That said, analysts forecast that M&G’s earnings will increase every year by a stunning 26.7% to end-2027.
Its full-year 2023 results saw adjusted operating profit before tax soar 28% year on year to ÂŁ797m. Operating capital generation jumped 21% to ÂŁ996m, giving a total of ÂŁ1.8bn over this and the previous year. Such funds can be a powerful engine for growth.
So are the shares undervalued?
The first part of my stock price assessment process involves comparing a share’s key valuations with its competitors.
M&G trades at a price-to-book ratio of just 1.3 – bottom of its peers, which average 3.7. The group comprises Man Group at 1.9, Intermediate Capital Group at 2.9, Legal & General at 3.5, and Hargreaves Lansdown at 6.4.
So, it looks very undervalued on this basis. And the same is true of its 0.8 price-to-sales ratio compared to its competitor average of 4.4.
However, on the price-to-earnings ratio it looks overvalued at 29.3 against a peer average of 23.1.
For further clarity on the valuation, I ran a discounted cash flow analysis – the second part of my assessment process. This evaluates the price at which a stock should be trading, based on future cash flow forecasts.
In M&G’s case, it shows the shares are 57% undervalued at their present price of £2.09. So their fair value is technically £4.86.
Market forces may push them lower or higher than that, of course. But it confirms to me how extremely undervalued the stock looks right now.
What about the dividend income?
Investors considering a ÂŁ10,000 holding in M&G could make ÂŁ15,506 in dividend income after 10 years. And after 30 years this could rise to ÂŁ155,935.
Adding in the initial ÂŁ10,000 would give a total value of the M&G holding of ÂŁ165,935. On the same 9.4% yield, this would generate ÂŁ15,598 a year in dividend income.
The figures are based on the dividends being compounded and on an average yield of 9.4%.
Yields can move down and up, depending on share price and annual dividends paid. But for M&G analysts forecast its yield will increase to 10% in 2025, 10.3% in 2026, and 11% in 2027.
Given its strong earnings growth potential, extreme undervaluation and huge yield, I will be buying more of the shares very soon.
This post was originally published on Motley Fool
