Choosing the right financial tool to evaluate a company can be a daunting task, especially when different models are giving you drastically different conclusions. For example, my discounted cash flow (DCF) model tells me that Rémy Cointreau SA’s (ENXTPA:RCO) is overvalued by 183.83%, but my relative valuation tells me it’s overvalued by 57.33%. Which model do I listen to and more importantly why?See our latest analysis for Rémy Cointreau
Deep-dive into intrinsic valuation
Forecasting anything into the distant future is difficult and the same applies to forecasting free cash flows (FCFs) for businesses. This is why I’ve decided to use analyst FCF forecasts in my DCF to see what the consensus view is while also removing some subjectivity. If you’re unfamiliar with valuation, the assumption behind every DCF is that a firm’s true value is derived from the sum of all its future FCFs, which is why quality forecasts are important. To obtain the per share intrinsic value of RCO, we must first discount the sum of RCO’s future FCFs by 8.18%, which gives us an equity value of €2.26B. Dividing by 49.93M shares outstanding, we get an intrinsic share price of €45.17. This means that the average broker analyst believes that RCO’s true value should be closer to €45.17 vs its current price of €128.2. Check out the source of my intrinsic value here.,
Before we accept this value and move on, let’s take a look at how reliable it is. Since our analysis relies on quality FCF forecasts, let’s see how many analyst forecasts we have by the final year of RCO’s 5-year forecast horizon. With only 3 analyst forecasts for RCO’s FCF in the fifth year, our DCF demonstrates that even broker analysts struggle to reliably forecast future cash flows for RCO after a few years. The lack of analyst forecasts undermines the conclusion we made earlier, which is a legitimate justification for attributing less weight to our DCF.
Deep-dive into relative valuation
While DCF models sum up future FCFs, relative valuation models are based on the idea that investors should pay the same price for two companies with identical risk and return profiles. Since the biggest dilemma is finding companies that are similar to RCO, a viable proxy would be the overall Beverage industry itself. To calculate the “true” value of RCO, we multiply RCO’s earnings by the industry’s P/E ratio to obtain a share price of €54.71, which means RCO is overvalued. But is this a dependable conclusion?
One quick way of finding out is to see if RCO shares a similar growth profile to the overall Beverage industry we are comparing it to. At 14.48% earnings growth next year, RCO has a dramatically different earnings growth profile to the overall Beverage industry, which is expected to grow at -2.12%. Unfortunately, this check shows that the Beverage industry is a poor proxy for RCO, which weakens our relative valuation analysis. Instead, we could dramatically improve our analysis by hand-picking companies that share similar growth profiles with RCO. I’d encourage you to do this by taking a look at RCO’s competitors.
Which Model Should I Care About?
Unfortunately, both models have their own merits and deficiencies, which means the truth lies somewhere in the middle. While intrinsic valuation is immune from market irrationality and mispricing, it is highly exposed to forecasting error. On the other hand, relative valuation is easy to calculate but affected by overall market mispricing. For example, relative valuation would not have been an effective tool to value a technology company at the height of the dotcom bubble in 2000. Instead of listening to one model over another, I encourage you to calculate a weighted average target share price based off both, applying a higher weight to the valuation method you think is more appropriate.
For RCO, I’ve compiled three important factors you should further examine:
- Financial Health: Does RCO have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does RCO’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.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of RCO? 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 for every stock on the ENXTPA every 6 hours. If you want to find the calculation for other stocks just search here.