Stock Analysis

Calculating The Fair Value Of Bang & Olufsen a/s (CPH:BO)

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CPSE:BO
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Does the February share price for Bang & Olufsen a/s (CPH:BO) 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. There's really not all that much to it, even though it might appear quite complex.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Bang & Olufsen

Crunching the numbers

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. 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, 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) estimate

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (DKK, Millions) kr.37.2m kr.99.0m kr.150.0m kr.189.7m kr.224.9m kr.254.3m kr.277.7m kr.295.7m kr.309.3m kr.319.5m
Growth Rate Estimate Source Analyst x2 Analyst x2 Analyst x2 Est @ 26.45% Est @ 18.57% Est @ 13.06% Est @ 9.2% Est @ 6.5% Est @ 4.6% Est @ 3.28%
Present Value (DKK, Millions) Discounted @ 6.6% kr.34.9 kr.87.2 kr.124 kr.147 kr.164 kr.174 kr.178 kr.178 kr.175 kr.169

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = kr.1.4b

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 (0.2%) 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 6.6%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = kr.319m× (1 + 0.2%) ÷ (6.6%– 0.2%) = kr.5.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= kr.5.0b÷ ( 1 + 6.6%)10= kr.2.7b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is kr.4.1b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of kr.31.1, the company appears about fair value at a 8.3% 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
CPSE:BO Discounted Cash Flow February 3rd 2021

The 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 Bang & Olufsen 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 6.6%, which is based on a levered beta of 1.216. 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.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or 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 Bang & Olufsen, we've compiled three relevant items you should assess:

  1. Risks: You should be aware of the 2 warning signs for Bang & Olufsen (1 is a bit concerning!) we've uncovered before considering an investment in the company.
  2. Future Earnings: How does BO'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. Simply Wall St updates its DCF calculation for every Danish stock every day, so if you want to find the intrinsic value of any other stock just search here.

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