Estimating The Fair Value Of Guangdong Transtek Medical Electronics Co., Ltd (SZSE:300562)

Key Insights

• The projected fair value for Guangdong Transtek Medical Electronics is CN¥10.41 based on 2 Stage Free Cash Flow to Equity
• With CN¥8.46 share price, Guangdong Transtek Medical Electronics appears to be trading close to its estimated fair value
• The average premium for Guangdong Transtek Medical Electronics' competitorsis currently 83%

How far off is Guangdong Transtek Medical Electronics Co., Ltd (SZSE:300562) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Guangdong Transtek Medical Electronics

What's The Estimated Valuation?

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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥42.0m	CN¥74.0m	CN¥95.0m	CN¥111.1m	CN¥125.2m	CN¥137.4m	CN¥148.0m	CN¥157.3m	CN¥165.6m	CN¥173.2m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ 16.90%	Est @ 12.71%	Est @ 9.78%	Est @ 7.73%	Est @ 6.29%	Est @ 5.29%	Est @ 4.58%
Present Value (CN¥, Millions) Discounted @ 8.3%	CN¥38.8	CN¥63.1	CN¥74.8	CN¥80.8	CN¥84.1	CN¥85.2	CN¥84.8	CN¥83.2	CN¥80.9	CN¥78.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥754m

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 2.9%. We discount the terminal cash flows to today's value at a cost of equity of 8.3%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥173m× (1 + 2.9%) ÷ (8.3%– 2.9%) = CN¥3.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥3.3b÷ ( 1 + 8.3%)¹⁰= CN¥1.5b

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¥2.3b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of CN¥8.5, the company appears about fair value at a 19% 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Guangdong Transtek Medical Electronics 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 8.3%, which is based on a levered beta of 0.950. 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 Guangdong Transtek Medical Electronics

Next Steps:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Guangdong Transtek Medical Electronics, we've compiled three essential factors you should explore:

1. Risks: Case in point, we've spotted 3 warning signs for Guangdong Transtek Medical Electronics you should be aware of.
2. Future Earnings: How does 300562'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 SZSE every day. If you want to find the calculation for other stocks just search here.

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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.