Does the December stock price for Central Asia Metals plc (LON: CAML) reflect what it’s really worth? Today we’re going to estimate the intrinsic value of the stock by discounting expected future cash flows to their present value. On this occasion we use the DCF (Discounted Cash Flow) model. Don’t let the jargon put you off, the math behind it is actually pretty simple.
We generally believe that a company’s value is the present value of all the cash it will generate in the future. However, a DCF is just one valuation metric among many and not without its flaws. For those who are familiar with stock analysis, the Simply Wall St analytical model might be of interest here.
We use the two-tier growth model, which simply means that we consider two phases in the company’s growth. In the initial phase, the company can have a higher growth rate, and in the second phase, a stable growth rate is usually assumed. In the first phase, we need to estimate the cash flows for the business over the next ten years. We use analyst estimates whenever possible. However, if these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume that companies with shrinking free cash flow will slow their rate of contraction and that companies with increasing free cash flow will slow their growth rate over this period. We do this to reflect that growth tends to slow down more in the first few years than in later years.
In general, we assume that a dollar today is more valuable than a dollar in the future. Hence, we discount the value of these future cash flows to their estimated value in today’s dollars:
(« Est » = FCF growth rate estimated by Simply Wall St) Present value of 10-year cash flow (PVCF) = 474 million. USD
The second level is also known as the final value. This is the company’s cash flow after the first stage. The Gordon growth formula is used to calculate the terminal value using a future annual growth rate equal to the 5-year average 10-year government bond yield of 1. 2%. We discount the terminal cash flows to today’s value at a cost of equity of 9. 0%.
Terminal Value (TV) = FCF2030 × (1 g) ÷ (r – g) = US $ 72 million. × (1 1. 2%) ÷ (9. 0% – 1st. 2%) = 931 million. U.S. dollar
Present Value of Terminal Value (PVTV) = TV / (1 r) 10 = US $ 931 million. ÷ (1 9. 0%) 10 = 393 million. U.S. dollar
The total value is the sum of the cash flows for the next ten years plus the discounted final value, which leads to the total capital value, which in this case is 867 million. USD is. The final step is to divide the equity value by the number of shares issued. Compared to the current UK share price of £ 2. 1, the company appears to be quite undervalued, at 43% discount from the current price of the stock. Ratings, however, are inaccurate instruments, more like a telescope – move a few degrees and land in a different galaxy. Keep that in mind.
The most important inputs for a discounted cash flow are now the discount rate and of course the actual cash flows. If you do not agree with this result, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclical nature of an industry or the future capital requirements of a company, so it does not give a complete picture of a company’s potential performance. Given that we view Central Asia Metals as a potential shareholder, the cost of equity is used as the discount rate rather than the cost of capital (or weighted average cost of capital, WACC) responsible for debt. In this calculation we used 9. 0% based on a leverage beta of 1. 127. Beta is a measure of the volatility of a stock compared to the overall market. We get our beta from the industry-standard average beta of comparable companies worldwide with an imposed limit between 0. 8 and 2. 0, which is a reasonable range for a stable business.
Rating is only one side of the coin in building your investment thesis and shouldn’t be the only metric you consider when researching a company. A foolproof assessment is not possible with a DCF model. Instead, the best use for a DCF model is to test certain assumptions and theories to determine whether they would result in the company becoming undervalued or overvalued. If a company is growing at a different rate, or if the cost of equity or the risk-free rate changes dramatically, performance can look very different. Why is the intrinsic value higher than the current share price? For metals from Central Asia, we’ve rounded up three additional factors that you should investigate further:
PS. Simply Wall St updates its DCF calculation for each UK share daily. So if you want to find out the intrinsic value of any other stock, just search here.
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This article from Simply Wall St is of a general nature. It is not a recommendation to buy or sell shares and does not take into account your goals or your financial situation. We want to provide you with a long-term, focused analysis based on fundamental data. Note that our analysis may not take into account the latest price sensitive company announcements or quality materials. Simply Wall St has no position in the stocks mentioned. * StockBrokers Interactive Brokers ranked as the lowest cost broker. com Annual Online Review 2020Do you have any feedback on this article? Concerned about the content? Contact us. Alternatively, send an email to the editorial team @ simplywallst. com.
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