In search of deep value? I think these 3 ASX dividend shares could be a downright steal

These companies could be what value investor dreams are made of.

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At its core, deep value takes value investing to the extreme. The goal is to find investments — such as those among ASX shares — that are priced significantly below their intrinsic value.

Locating these diamonds in the rough is what helped the late Ben Graham (Warren Buffett's mentor) achieve 17% annualised returns over more than 20 years.

In order to discover these deep-value companies, Graham would search for businesses trading at valuation multiples that were considered low. For example, companies with a price-to-earnings (P/E) ratio below 10 or a price-to-book (P/B) ratio below 1.

Curious to find some deep value on the local boards, I dug up three ASX shares that I'd consider extremely cheap right now.

Deeply discounted dividend-paying ASX shares

Adairs Ltd (ASX: ADH)

At a P/E of 7.1 times earnings, Adairs is a homewares and furnishings retailer that I believe is trading far below its intrinsic value.

At present, much of the retail sector is being cheaply valued due to the expected impacts on discretionary spending amid higher interest rates. However, it is unlikely that these suppressed multiples will last forever.

Adairs posted a 34% increase in sales for the first half of FY23. I believe Adairs can grow its sales at a 5% per annum clip over the next five years (at minimum) and maintain a net income margin of roughly 7% — which seems like little to ask.

Based on these figures and an improved P/E ratio of 12 times earnings, I estimate the market capitalisation to be in the ballpark of $690 million. That would be approximately double today's market valuation.

Nick Scali Limited (ASX: NCK)

Much like Adairs, Nick Scali is another furniture retailer that is trading on a lower earnings multiple than its peers. This might lead investors to think that Nick Scali is a lesser company than others, but the numbers definitely don't paint that picture.

In the first half, the sofa seller posted sales growth of 57.4% compared to the prior corresponding period. Furthermore, the group's gross margins improved slightly to a magnificent 62%. It's hard to think of Nick Scali as anything other than one of the best ASX retail shares on the market at the moment.

Going forward, I'm expecting sales growth to temper as the property market cools off. Though, if similar earnings can be sustained over the next five years, I'd personally estimate Nick Scali's intrinsic value to be around $14.80 per share — 69% above its current valuation.

Macmahon Holdings Ltd (ASX: MAH)

Trading on a P/E ratio of 6 times earnings and a P/B of 0.5, this ASX share is possibly the deepest value on this list. Macmahon Holdings provides mining services to a diverse pool of clients across the world, including Newcrest Mining Ltd (ASX: NCM) and St Barbara Ltd (ASX: SBM).

The steep discount could be attributed to the cyclic nature of the mining industry. No one wants to be an investor when the boom is over. Though, Macmahon is involved in several mining contracts for copper and lithium — which are expected to enjoy prolonged demand due to the electrification trend.

As of 31 December 2022, the company had an order book of $5.6 billion and guided for $1.85 billion to $1.95 billion in revenue for FY23.

My conservative estimate for Macmahon's valuation in five years would be around $540 million if it were to trade more in line with the industry average P/E ratio of 9 times. This would represent a 90% increase from the current valuation.

Motley Fool contributor Mitchell Lawler has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Adairs. The Motley Fool Australia has positions in and has recommended Adairs. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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