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How far off is The Character Group plc (LON:CCT) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today’s value. I will be using the discounted cash flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. Please also note that this article was written in February 2019 so be sure check out the updated calculation by following the link below.
Crunching the numbers
I’m using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. In the first stage we need to estimate the cash flows to the business over the next five years. The sum of these cash flows is then discounted to today’s value.
5-year cash flow forecast
|Levered FCF (£, Millions)||£6.67||£7.09||£7.54||£8.02||£8.53|
|Source||Est @ 6.34%||Est @ 6.34%||Est @ 6.34%||Est @ 6.34%||Est @ 6.34%|
|Present Value Discounted @ 8.25%||£6.16||£6.05||£5.95||£5.84||£5.74|
Present Value of 5-year Cash Flow (PVCF)= UK£30m
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 the GDP. In this case I have used the 10-year government bond rate (1.2%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 8.2%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = UK£8.5m × (1 + 1.2%) ÷ (8.2% – 1.2%) = UK£123m
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = UK£123m ÷ ( 1 + 8.2%)5 = UK£83m
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is UK£113m. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of £5.31. Compared to the current share price of £5.4, the stock is fair value, maybe slightly overvalued and not available at a discount at this time.
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Character Group as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 8.2%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on 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. For CCT, I’ve compiled three key factors you should further examine:
- Financial Health: Does CCT 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 CCT’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 CCT? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. Simply Wall St does a DCF calculation for every GB stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. On rare occasion, data errors may occur. Thank you for reading.