# Calculating The Intrinsic Value Of Jumbo Interactive Limited (ASX:JIN)

By
Simply Wall St
Published
August 28, 2021

In this article we are going to estimate the intrinsic value of Jumbo Interactive Limited (ASX:JIN) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Jumbo Interactive

### Crunching the numbers

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

#### 10-year free cash flow (FCF) forecast

 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 Levered FCF (A\$, Millions) AU\$35.9m AU\$42.5m AU\$47.4m AU\$51.4m AU\$54.8m AU\$57.6m AU\$60.1m AU\$62.2m AU\$64.1m AU\$65.8m Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ 11.43% Est @ 8.57% Est @ 6.58% Est @ 5.18% Est @ 4.2% Est @ 3.52% Est @ 3.04% Est @ 2.7% Present Value (A\$, Millions) Discounted @ 7.3% AU\$33.5 AU\$36.9 AU\$38.4 AU\$38.8 AU\$38.6 AU\$37.8 AU\$36.7 AU\$35.5 AU\$34.1 AU\$32.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU\$362m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 7.3%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = AU\$66m× (1 + 1.9%) ÷ (7.3%– 1.9%) = AU\$1.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU\$1.3b÷ ( 1 + 7.3%)10= AU\$621m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU\$983m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU\$14.9, the company appears about fair value at a 5.2% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

### The assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Jumbo Interactive 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 accounts for debt. In this calculation we've used 7.3%, which is based on a levered beta of 1.134. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

### Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Jumbo Interactive, we've compiled three fundamental aspects you should explore:

1. Risks: Take risks, for example - Jumbo Interactive has 2 warning signs (and 1 which is potentially serious) we think you should know about.
2. Future Earnings: How does JIN'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.
3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St updates its DCF calculation for every Australian stock every day, so if you want to find the intrinsic value of any other stock just search here.

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