I was just reading Goldman Sachs research on my Commsec...

I was just reading Goldman Sachs research on my Commsec account.

They have a buy recommendation on FMG & Rio (not BHP) and FMG target price of $9.80 (research release date 13 August 2019).

"Upgrading iron ore, Buy RIO and FMG: We think iron ore will rebound to US$110-115/t in 4Q post Chinese Golden week and recommend investors buy RIO and FMG post the recent share price weakness."

"We increase our FMG NAV to A$7.73/sh and TP to A$9.8/sh (set at 50:50 NAV:3.5x EBITDA NTM) and upgrade to Buy on valuation (0.9x NAV) and an attractive FCF yield of 13% in FY20 despite higher capex and cash tax."

They have following graph re forward estimates and earnings per share.



I am interested by the EPS on right of graph. If EPS plays out as predicted, then consider the following simple analysis.

You buy FMG share today for $7.50 - your payback in year 1 is $1.50 (whether in dividends or profit retention which improves the balance sheet). Therefore after year 1, your cost of FMG share has effectively been reduced to $6. In year 2, EPS is predicted at 70 cents per share and on your "reduced" $6 cost base, the stock is now trading on PE ratio of 8.57 ($6 divided by 70 cents), even in a more normal IO pricing year (if we consider 2020 as an abnormal year).

Therefore, my conclusion based on fundamentals, you can't go wrong buying FMG at current price of $7.50. Remember, Goldman Sachs has net asset values at $7.73.