How far off is PageGroup plc (LON:PAGE) 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. 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.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Step by step through the calculation
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.
Generally we assume that a dollar today is more valuable than a dollar in the future, 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
|Levered FCF (£, Millions)||UK£60.8m||UK£87.0m||UK£97.0m||UK£104.0m||UK£109.6m||UK£114.0m||UK£117.6m||UK£120.5m||UK£122.8m||UK£124.9m|
|Growth Rate Estimate Source||Analyst x6||Analyst x5||Analyst x1||Est @ 7.27%||Est @ 5.36%||Est @ 4.03%||Est @ 3.1%||Est @ 2.44%||Est @ 1.99%||Est @ 1.67%|
|Present Value (£, Millions) Discounted @ 5.8%||UK£57.5||UK£77.6||UK£81.8||UK£82.9||UK£82.5||UK£81.1||UK£79.0||UK£76.5||UK£73.7||UK£70.8|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£763m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (0.9%) 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 5.8%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = UK£125m× (1 + 0.9%) ÷ (5.8%– 0.9%) = UK£2.6b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£2.6b÷ ( 1 + 5.8%)10= UK£1.4b
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£2.2b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£5.8, the company appears about fair value at a 18% discount to where the stock price trades currently. 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.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 PageGroup 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 5.8%, which is based on a levered beta of 0.928. 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.
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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For PageGroup, there are three relevant elements you should look at:
- Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with PageGroup , and understanding it should be part of your investment process.
- Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for PAGE's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- 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. 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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PageGroup plc, together with its subsidiaries, provides recruitment consultancy and other ancillary services in the United Kingdom, rest of Europe, the Middle East, Africa, the Asia Pacific, and the Americas.
Flawless balance sheet, undervalued and pays a dividend.