Does the November Pierce Group AB (publ) (STO: PIERCE) share price reflect what it is really worth? Today we’re going to estimate the intrinsic value of the stock by taking expected future cash flows and discounting them to today’s value. One way to do this is to use the Discounted Cash Flow (DCF) model. Before you think you won’t be able to figure it out, read on! It’s actually a lot less complex than you might imagine.
We draw your attention to the fact that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. If you want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St.
Discover our latest analysis for Pierce Group
We are going to use a two-step DCF model, which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “steady growth”. To begin with, we need to get cash flow estimates for the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF (SEK, millions)||76.0 kr||102.5 m kr||â¬ 122.2m||138.8 m kr||152.1m kr||162.5 m kr||170.4 m kr||176.3 m kr||180.8 kr||184.3 kr|
|Source of estimated growth rate||Analyst x2||Analyst x2||East @ 19.23%||East @ 13.56%||Est @ 9.59%||Est @ 6.81%||Est @ 4.87%||Is @ 3.51%||Is 2.55%||East @ 1.89%|
|Present value (SEK, million) discounted at 5.0%||72.4 kr||93.0 kr||106 kr||kr114||kr119||kr121||kr121||kr119||kr117||113 kr|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = kr1.1b
After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. For a number of reasons, a very conservative growth rate is used that cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (0.3%) to estimate future growth. Similar to the 10-year âgrowthâ period, we discount future cash flows to their present value, using a cost of equity of 5.0%.
Terminal value (TV)= FCF2031 Ã (1 + g) Ã· (r – g) = kr184m Ã (1 + 0.3%) Ã· (5.0% – 0.3%) = kr4.0b
Present value of terminal value (PVTV)= TV / (1 + r)ten= kr4.0b Ã· (1 + 5.0%)ten= kr2.4b
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is kr3.5b. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of 52.1 crowns, the company appears to be quite undervalued with a 41% discount from the current share price. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. If you don’t agree with these results, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we view Pierce Group as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which takes into account debt. In this calculation, we used 5.0%, which is based on a leveraged beta of 1.068. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average beta from globally comparable companies, with a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.
To move on :
Valuation is only one side of the coin in terms of building your investment thesis, and ideally, it won’t be the only piece of analysis you look at for a business. The DCF model is not a perfect equity valuation tool. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. What is the reason why the stock price is below intrinsic value? For Pierce Group, we’ve compiled three more things you should explore:
- Risks: To do this, you need to know the 2 warning signs we spotted with Pierce Group.
- Future benefits: How does PIERCE’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth expectations chart.
- Other strong companies: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you might not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each OM share. If you want to find the calculation for other actions, just search here.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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