The Zip Co Ltd (ASX: ZIP) share price has fallen a long way over the past year.
With the buy now, pay later provider trading around $1.92 on Wednesday, its valuation is starting to look remarkably low.
In fact, Zip is trading at a lower earnings multiple than Australia's big four banks, despite having much stronger earnings growth expectations.
So, has the market become too pessimistic about Zip's future?
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How cheap is the Zip share price?
I think Zip's current valuation is difficult to ignore. According to CommSec consensus forecasts, the company is expected to generate earnings per share (EPS) of 14.7 cents in FY27, rising to 16 cents in FY28 and 20.9 cents in FY29.
At $1.92, that puts Zip shares on a forward price-to-earnings (PE) ratio of approximately 13.1 times FY27 earnings. That multiple falls to 12 times for FY28 and just 9.2 times for FY29.
I think those figures are compelling, especially when considering the growth analysts are expecting. Between FY27 and FY29, Zip's earnings are forecast to increase by an average of approximately 19% annually.
And here's something I find alarming about its valuation. Commonwealth Bank of Australia (ASX: CBA) shares are currently trading on approximately 25 times forward earnings, while ANZ Group Holdings Ltd (ASX: ANZ) trades closer to 16 times according to consensus estimates.
Yet their earnings growth expectations are considerably more modest, with only limited growth being forecast.
Of course, the banks have established earnings records, enormous customer bases, and relatively predictable profits. But I think the size of the discount is excessive when considering Zip's potential to grow earnings over the next few years.
To put things in context, I calculate that if the Zip share price were to trade on the same forward PE ratio as CBA, it would be worth $3.68 today.
Is the discount justified?
There are certainly reasons why investors are cautious about Zip shares.
The company's recent US fraud incident resulted in $10.1 million of additional operating expenses and raised concerns about its credit controls.
And while the incident has been contained, investors will understandably want reassurance that similar problems can be prevented.
Credit losses are another consideration. Zip's profitability depends on its ability to manage lending risks while continuing to grow transaction volumes.
If economic conditions deteriorate or customers struggle to repay their balances, earnings could come under pressure.
However, I don't believe these concerns justify the current valuation. Zip's underlying growth remains strong, with US transaction volumes increasing 34.1% during the first quarter of FY27.
Revenue in the region also increased 32% in local currency. And despite the fraud-related disruption, management maintained its FY27 guidance for $340 million in group cash earnings before tax, depreciation and amortisation.
I think this demonstrates that Zip still has considerable growth potential.
As its US operations expand, I believe there are opportunities to improve profitability and generate stronger earnings from its growing customer base.
The company will need to deliver on those expectations, but I think its current valuation leaves room for investors to be rewarded.
Foolish takeaway
For me, the Zip share price looks dirt cheap at $1.92.
The company has some challenges to overcome, and I wouldn't expect investor confidence to recover overnight.
However, I believe the combination of strong growth prospects and a relatively modest earnings multiple creates an attractive opportunity.
If Zip delivers anything close to the earnings growth analysts are forecasting, I think its shares could be worth considerably more in a few years.
