Are Digia Oyj (HEL:DIGIA) Investors Paying Above The Intrinsic Value?

How far off is Digia Oyj (HEL:DIGIA) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Digia Oyj

Is Digia Oyj fairly valued?

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (€, Millions)	€10.2m	€13.8m	€12.9m	€11.7m	€10.9m	€10.5m	€10.2m	€9.96m	€9.83m	€9.75m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x2	Analyst x2	Est @ -6.21%	Est @ -4.26%	Est @ -2.9%	Est @ -1.95%	Est @ -1.28%	Est @ -0.81%
Present Value (€, Millions) Discounted @ 7.0%	€9.5	€12.0	€10.5	€8.9	€7.8	€7.0	€6.3	€5.8	€5.3	€4.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €77m

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 0.3%. We discount the terminal cash flows to today's value at a cost of equity of 7.0%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = €9.8m× (1 + 0.3%) ÷ (7.0%– 0.3%) = €145m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= €145m÷ ( 1 + 7.0%)¹⁰= €73m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €150m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of €7.5, the company appears potentially overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

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 Digia Oyj 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 7.0%, which is based on a levered beta of 1.163. 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.

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. 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. Why is the intrinsic value lower than the current share price? For Digia Oyj, there are three additional factors you should consider:

1. Risks: For example, we've discovered 1 warning sign for Digia Oyj that you should be aware of before investing here.
2. Future Earnings: How does DIGIA'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 HLSE 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. 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.
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