Calculating The Fair Value Of Shanghai MicroPort EP MedTech Co., Ltd. (SHSE:688351)

Key Insights

• The projected fair value for Shanghai MicroPort EP MedTech is CN¥20.84 based on 2 Stage Free Cash Flow to Equity
• With CN¥21.80 share price, Shanghai MicroPort EP MedTech appears to be trading close to its estimated fair value
• Analyst price target for 688351 is CN¥29.15, which is 40% above our fair value estimate

Does the August share price for Shanghai MicroPort EP MedTech Co., Ltd. (SHSE:688351) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Shanghai MicroPort EP MedTech

Crunching The Numbers

We're 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 a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. 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.

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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (CN¥, Millions)	CN¥18.7m	CN¥63.5m	CN¥153.0m	CN¥259.5m	CN¥347.8m	CN¥433.7m	CN¥512.3m	CN¥581.7m	CN¥641.9m	CN¥693.8m
Growth Rate Estimate Source	Analyst x3	Analyst x2	Analyst x2	Analyst x2	Est @ 34.04%	Est @ 24.68%	Est @ 18.13%	Est @ 13.55%	Est @ 10.34%	Est @ 8.09%
Present Value (CN¥, Millions) Discounted @ 7.4%	CN¥17.4	CN¥55.0	CN¥123	CN¥195	CN¥243	CN¥282	CN¥310	CN¥328	CN¥336	CN¥338

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥2.2b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 (2.9%) 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 7.4%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = CN¥694m× (1 + 2.9%) ÷ (7.4%– 2.9%) = CN¥16b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥16b÷ ( 1 + 7.4%)¹⁰= CN¥7.6b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CN¥9.8b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of CN¥21.8, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

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 Shanghai MicroPort EP MedTech 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 7.4%, which is based on a levered beta of 0.922. 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.

SWOT Analysis for Shanghai MicroPort EP MedTech

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Shanghai MicroPort EP MedTech, there are three relevant items you should assess:

1. Risks: You should be aware of the 1 warning sign for Shanghai MicroPort EP MedTech we've uncovered before considering an investment in the company.
2. Future Earnings: How does 688351'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SHSE every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St 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. Simply Wall St has no position in any stocks mentioned.