Cheap ASX shares can be deceptive.
Sometimes a low valuation is simply the market recognising that earnings are about to fall. Other times, though, the share price does not seem to reflect just how much a business could be earning a few years from now.
That second group is what interests me.
I have found three ASX shares where the forward numbers look increasingly difficult to ignore. They operate in completely different industries and come with very different risks, but I think all three could be worth considerably more if current earnings expectations prove even broadly correct.
The first one is already reasonably priced today. Look another year or two ahead, though, and the valuation starts to look extraordinary.
Northern Star Resources Ltd (ASX: NST)
Northern Star shares are trading around $24.76 at the time of writing.
On FY27 earnings alone, I would not necessarily describe that price as dirt cheap.
Consensus estimates point to earnings per share (EPS) of $1.35, putting the gold miner on a forward price-to-earnings (P/E) ratio of around 18 times.
That looks reasonable enough for one of Australia’s largest gold producers. But the investment case changes materially when I look further ahead.
Analysts expect EPS to jump to $2.41 in FY28 and $3.31 in FY29. At today’s share price, those estimates imply P/E ratios of roughly 10 times and 7.5 times, respectively.
That is where Northern Star starts to look seriously undervalued to me.
The dividend outlook moves in the same direction. Consensus forecasts point to dividends per share of 51.6 cents in FY27, 73 cents in FY28, and 86.2 cents in FY29. At the current share price, the FY29 forecast would represent a dividend yield of around 3.5%.
Of course, there is an important reason the market may be reluctant to fully price those estimates in today. Northern Star sells gold, and the gold price will have a major influence on whether those earnings forecasts are achievable.
If the gold price remains higher for longer and production growth plans are delivered, I think it is very likely there will be a large increase in Northern Star’s profits.
But it is important to acknowledge that if gold falls sharply instead, those EPS estimates could come down just as quickly.
That commodity sensitivity is the main risk I would keep in mind. But for investors who want gold exposure and are comfortable with that uncertainty, I think the potential reward is substantial.
An ASX share trading at around 7.5 times FY29 forecast earnings does not need everything to go perfectly to get my attention.
And Northern Star is only the first of my three picks.
Universal Store Holdings Ltd (ASX: UNI)
My second pick comes from a completely different corner of the market.
Universal Store shares are trading around $8.04 at the time of writing, and I think the current valuation leaves plenty of room for the business to keep delivering.
The retailer sits behind brands including Universal Store, Perfect Stranger, and Thrills, giving it exposure to younger consumers across fashion and lifestyle categories.
Consensus estimates currently point to EPS of 57.8 cents in FY27, rising to 63.2 cents in FY28, and 68.9 cents in FY29.
At $8.04, that puts the shares on roughly 14 times FY27 earnings, falling to around 13 times FY28 earnings and less than 12 times FY29 earnings. I think that is a low price to pay if Universal Store can continue growing profits at the rate analysts expect.
The dividend makes the valuation even more interesting. Consensus forecasts point to dividends of 45 cents per share in FY27, 48 cents in FY28, and 53 cents in FY29.
At today’s price, the FY27 estimate represents a dividend yield of around 5.6%. By FY29, that potential yield rises to approximately 6.6%.
But retail shares obviously come with risks. Consumer spending can weaken, fashion preferences can change quickly, and a retailer still has to get its product, pricing, inventory, and store strategy right.
But at the current valuation I am not being asked to pay a growth-stock multiple for Universal Store. At around 14 times FY27 earnings, I think there is already a reasonable amount of caution built into the price.
If the company can keep lifting EPS towards 69 cents over the next few years while maintaining a strong dividend, I think the current share price could ultimately prove too low.
Zip is probably the highest-risk pick of these ASX shares, but it may also offer the most obvious valuation upside.
The shares are trading around $2.23 at the time of writing. Consensus forecasts point to EPS of 15 cents in FY27, 18 cents in FY28, and 22 cents in FY29. That means investors are paying around 15 times FY27 earnings today.
Already, I think that looks quite reasonable for a business expected to grow profits strongly.
But again, the outer years are where things become much more interesting. The P/E ratio falls to around 12.4 times FY28 earnings and just over 10 times FY29 earnings if the forecasts are achieved.
Meanwhile, EPS would increase by almost 47% between FY27 and FY29. That combination is what makes Zip look undervalued to me.
The company does still have plenty to prove. I want to see Zip continue taking a greater share of the payments market in the United States and Australia, while growing transaction volumes and its customer base.
Just as importantly, that growth needs to be disciplined. Adding users is not particularly valuable if bad debts rise too quickly alongside them. Credit quality needs to remain under control as the business gets larger.
If Zip can balance those two sides of the equation, growing payment volumes while maintaining sensible lending standards, I think the earnings forecasts become much easier to believe.
And if the company eventually earns 22 cents per share while continuing to grow, I struggle to see why investors would permanently value it at around 10 times earnings.
That does not mean the path will be smooth. Zip shares have been extremely volatile before, and sentiment towards buy now, pay later businesses can change quickly.
But at the current price, I think the valuation gives me enough room to accept that uncertainty.
Foolish takeaway
I think the market is being too cautious about what these businesses could earn over the next few years.
There is certainly some uncertainty surrounding all three, but I believe their growth prospects make the current valuations hard to ignore.
I’d be happy to buy at today’s prices and give them time to prove their worth.
The post 3 dirt cheap ASX shares I think are undervalued today appeared first on The Motley Fool Australia.
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Motley Fool contributor Grace Alvino has positions in Northern Star Resources. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Universal Store. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
