Calculating The Intrinsic Value Of Givex Information Technology Group Limited (TSE:GIVX)

Published
August 14, 2022
TSX:GIVX
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Does the August share price for Givex Information Technology Group Limited (TSE:GIVX) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Givex Information Technology Group

Step By Step Through The Calculation

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 start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF (CA$, Millions) CA$4.03m CA$3.88m CA$3.80m CA$3.76m CA$3.75m CA$3.76m CA$3.79m CA$3.83m CA$3.87m CA$3.93m
Growth Rate Estimate Source Est @ -6.01% Est @ -3.72% Est @ -2.11% Est @ -0.99% Est @ -0.2% Est @ 0.35% Est @ 0.73% Est @ 1% Est @ 1.19% Est @ 1.32%
Present Value (CA$, Millions) Discounted @ 6.3% CA$3.8 CA$3.4 CA$3.2 CA$2.9 CA$2.8 CA$2.6 CA$2.5 CA$2.3 CA$2.2 CA$2.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CA$27m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 have used the 5-year average of the 10-year government bond yield (1.6%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 6.3%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = CA$3.9m× (1 + 1.6%) ÷ (6.3%– 1.6%) = CA$85m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CA$85m÷ ( 1 + 6.3%)10= CA$46m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CA$73m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of CA$0.6, the company appears about fair value at a 6.6% 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.

dcf
TSX:GIVX Discounted Cash Flow August 14th 2022

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Givex Information Technology 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 accounts for debt. In this calculation we've used 6.3%, which is based on a levered beta of 1.101. 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:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Givex Information Technology Group, there are three important factors you should further research:

  1. Risks: We feel that you should assess the 2 warning signs for Givex Information Technology Group (1 makes us a bit uncomfortable!) we've flagged before making an investment in the company.
  2. Future Earnings: How does GIVX'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 Solid Businesses: 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 business fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the TSX every day. If you want to find the calculation for other stocks just search here.

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