Investors In FirstService Corporation (TSE:FSV) Are Paying Above The Intrinsic Value

Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of FirstService Corporation (TSX:FSV) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. I will be using the discounted cash flows (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. Please also note that this article was written in December 2017 so be sure check out the updated calculation by following the link below. View our latest analysis for FirstService

What's the value?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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 the sum of these cash flows to arrive at a present value estimate.

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 2.1%. We discount this to today's value at a cost of equity of 8.4%.

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is CA$1,769. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of CA$63.39, which, compared to the current share price of CA$88.35, we find that FirstService is rather overvalued at the time of writing.

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 FirstService 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 8.4%, which is based on a levered beta of 0.8. 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.

Next Steps:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For FSV, there are three pertinent aspects you should further research:

1. Financial Health: Does FSV 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 FSV'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 FSV? 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 does a DCF calculation for every CA stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.