Is There An Opportunity With Beeks Financial Cloud Group plc's (LON:BKS) 21% Undervaluation?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Beeks Financial Cloud Group fair value estimate is UK£1.37
• Beeks Financial Cloud Group's UK£1.08 share price signals that it might be 21% undervalued

Today we will run through one way of estimating the intrinsic value of Beeks Financial Cloud Group plc (LON:BKS) by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for Beeks Financial Cloud Group

What's The Estimated Valuation?

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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (£, Millions)	UK£190.0k	UK£1.51m	UK£2.48m	UK£3.63m	UK£4.81m	UK£5.93m	UK£6.93m	UK£7.77m	UK£8.47m	UK£9.05m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Est @ 65.07%	Est @ 46.00%	Est @ 32.66%	Est @ 23.32%	Est @ 16.78%	Est @ 12.20%	Est @ 9.00%	Est @ 6.75%
Present Value (£, Millions) Discounted @ 8.3%	UK£0.2	UK£1.3	UK£2.0	UK£2.6	UK£3.2	UK£3.7	UK£4.0	UK£4.1	UK£4.1	UK£4.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£29m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 1.5%. We discount the terminal cash flows to today's value at a cost of equity of 8.3%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£9.0m× (1 + 1.5%) ÷ (8.3%– 1.5%) = UK£135m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£135m÷ ( 1 + 8.3%)¹⁰= UK£61m

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£90m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£1.1, the company appears a touch undervalued at a 21% 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Beeks Financial Cloud Group 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 8.3%, which is based on a levered beta of 1.150. 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 shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For Beeks Financial Cloud Group, we've compiled three pertinent aspects you should further research:

1. Risks: For example, we've discovered 1 warning sign for Beeks Financial Cloud Group that you should be aware of before investing here.
2. Future Earnings: How does BKS'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 AIM 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. 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.