Aston Martin Lagonda Global Holdings plc (LON:AML) Shares Could Be 50% Below Their Intrinsic Value Estimate

Key Insights

• Aston Martin Lagonda Global Holdings' estimated fair value is UK£3.4 based on 2 Stage Free Cash Flow to Equity
• Current share price of UK£1.7 suggests Aston Martin Lagonda Global Holdings is 50% undervalued
• Analyst price target for AML is UK£2.71 which is 20% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Aston Martin Lagonda Global Holdings plc (LON:AML) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. 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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Aston Martin Lagonda Global Holdings

Crunching The Numbers

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 start off with, we need to estimate 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (£, Millions)	-UK£123.1m	UK£14.4m	UK£78.0m	UK£147.4m	UK£239.5m	UK£345.1m	UK£452.6m	UK£552.7m	UK£639.8m	UK£712.3m
Growth Rate Estimate Source	Analyst x4	Analyst x3	Analyst x1	Est @ 88.93%	Est @ 62.55%	Est @ 44.08%	Est @ 31.15%	Est @ 22.10%	Est @ 15.77%	Est @ 11.34%
Present Value (£, Millions) Discounted @ 15%	-UK£107	UK£11.0	UK£51.7	UK£85.2	UK£121	UK£152	UK£173	UK£185	UK£186	UK£181

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£1.0b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 1.0%. We discount the terminal cash flows to today's value at a cost of equity of 15%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = UK£712m× (1 + 1.0%) ÷ (15%– 1.0%) = UK£5.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£5.3b÷ ( 1 + 15%)¹⁰= UK£1.3b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£2.4b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of UK£1.7, the company appears quite good value at a 50% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Aston Martin Lagonda Global Holdings 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 15%, which is based on a levered beta of 2.000. 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 Aston Martin Lagonda Global Holdings

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Aston Martin Lagonda Global Holdings, there are three fundamental aspects you should further research:

1. Risks: Take risks, for example - Aston Martin Lagonda Global Holdings has 2 warning signs we think you should be aware of.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for AML's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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 British stock every day, so if you want to find the intrinsic value of any other stock 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.