National Grid’s (LSE: NG) share price has fallen 15% since its 2 March one-year traded high of £12.09. But that drop alone does not make it a bargain, because price and value are two different things in shares.
Price is simply the number buyers and sellers settle on at a given moment. But value reflects the underlying strength and prospects of the business itself.
For long‑term investors, that distinction is crucial. Over time, market prices tend to drift towards a company’s true worth — its ‘fair value’. This is why understanding that gap is one of the most powerful tools for maximising long-term investor profits.
So, what is really going on here?
How does it compare to peers?
As a long-term investor, I am cautious about leaning too heavily on simple valuation comparisons between stocks.
They are backward‑looking, telling you more about where a share price has travelled than where the business itself is heading. Even the forward versions only stretch a year into the future — the same narrow horizon analysts use for price targets.
Still, these relative measures can be useful as a quick temperature check, showing how a company is priced against competitors.
National Grid’s forward price-to-sales ratio of 3 looks expensive compared with its peers’ average of 1.4. That group includes E.ON at 0.6, Engie at 0.9, Enel at 1.2, and Iberdrola also at 3.
However, the picture flips when looking at earnings. National Grid trades on 13.5 times forward earnings, below the peer average of 16, making it look relatively inexpensive here.
The same is true of its price‑to‑book ratio: at 1.5, it sits comfortably below the 2.4 average of its competitors.
What does the acid test reveal?
To judge whether National Grid’s current share price is fundamentally under- or overvalued, I need to ascertain its ‘fair value’. During my years in investment bank trading, I found the optimal way to do this was through discounted cash flow (DCF) analysis.
It focuses on the cash any business is likely to generate. It then discounts those flows back to today to produce a per‑share valuation. The less certainty there is around the forecasts, the higher the discount rate needs to be. And differing assumptions occasionally here are why analysts’ DCF can sometimes vary.
But using my own DCF modelling, including an 8% discount rate, National Grid screens as 40% overvalued at its current £12.12 price.
That implies a fair value of £8.66 — significantly below where the shares trade today.
My investment view
I would never consider a stock that looks this overvalued. Even if I already held it, I would reassess my position, unless its earnings prospects were exceptional, which might allow the price to grow into its valuation in the short term.
However, analysts forecast National Grid’s earnings will grow by an average 11.2% a year to end-2028. This would not fill the gap between valuation and price.
And there are risks here too. One is any tightening of the regulatory framework that could squeeze its margins. Another is rising interest rates that could worsen its already huge debt repayments on government-mandated infrastructure improvements.
That said, I do have my eye on other FTSE firms that are deeply undervalued and offer high dividend yields while investors wait for that gap to close.
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Simon Watkins does not hold any positions in the companies mentioned.
