Estimating The Intrinsic Value Of Bytes Technology Group plc (LON:BYIT)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Bytes Technology Group fair value estimate is UK£4.90
• With UK£5.21 share price, Bytes Technology Group appears to be trading close to its estimated fair value
• Our fair value estimate is 19% lower than Bytes Technology Group's analyst price target of UK£6.04

Does the May share price for Bytes Technology Group plc (LON:BYIT) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

We've discovered 1 warning sign about Bytes Technology Group. View them for free.

Is Bytes Technology Group Fairly Valued?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (£, Millions)	UK£62.2m	UK£57.7m	UK£72.9m	UK£74.7m	UK£76.3m	UK£78.0m	UK£79.8m	UK£81.6m	UK£83.5m	UK£85.4m
Growth Rate Estimate Source	Analyst x5	Analyst x1	Analyst x4	Analyst x1	Est @ 2.23%	Est @ 2.25%	Est @ 2.27%	Est @ 2.28%	Est @ 2.28%	Est @ 2.29%
Present Value (£, Millions) Discounted @ 8.1%	UK£57.6	UK£49.3	UK£57.7	UK£54.7	UK£51.7	UK£48.9	UK£46.3	UK£43.8	UK£41.4	UK£39.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£491m

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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 8.1%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = UK£85m× (1 + 2.3%) ÷ (8.1%– 2.3%) = UK£1.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£1.5b÷ ( 1 + 8.1%)¹⁰= UK£692m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is UK£1.2b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£5.2, the company appears around fair value at the time of writing. 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. 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 Bytes Technology 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 8.1%, which is based on a levered beta of 1.130. 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.

See our latest analysis for Bytes Technology Group

SWOT Analysis for Bytes Technology Group

Looking Ahead:

Whilst important, the DCF calculation 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. 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. For Bytes Technology Group, we've put together three fundamental aspects you should explore:

1. Risks: To that end, you should be aware of the 1 warning sign we've spotted with Bytes Technology Group .
2. Future Earnings: How does BYIT'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 High Quality Alternatives: Do you like a good all-rounder? 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 valuation for every stock on the LSE 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.