Crunching the numbers
I’m using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. To start off with we need to estimate the next five years of cash flows. Where possible I use analyst estimates, but when these aren’t available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow forecast
|Levered FCF (GBP, Millions)||£3.10||£3.10||£3.66||£4.28||£4.96|
|Source||Analyst x1||Analyst x1||Extrapolated @ (18%, capped from 35.73%)||Extrapolated @ (17%, capped from 35.73%)||Extrapolated @ (16%, capped from 35.73%)|
|Present Value Discounted @ 9.31%||£2.84||£2.59||£2.80||£3.00||£3.18|
Present Value of 5-year Cash Flow (PVCF)= £14
The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 1.5%. We discount this to today’s value at a cost of equity of 9.3%.
Terminal Value (TV) = FCF2021 × (1 + g) ÷ (r – g) = £5 × (1 + 1.5%) ÷ (9.3% – 1.5%) = £64
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = £64 / ( 1 + 9.3%)5 = £41
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is £56. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of £0.10, which, compared to the current share price of £0.11, we see that Nasstar is fair value, maybe slightly overvalued and not available at a discount at this time.
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Nasstar as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 9.3%, which is based on a levered beta of 0.919. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. For NASA, I’ve compiled three relevant factors you should further research:
1. Financial Health: Does NASA have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does NASA’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
2. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of NASA? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. The Simply Wall St app conducts a discounted cash flow for every stock on the AIM every 6 hours. If you want to find the calculation for other stocks just search here.