FDM Group (Holdings) plc's (LON:FDM) Intrinsic Value Is Potentially 51% Above Its Share Price

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, FDM Group (Holdings) fair value estimate is UK£3.36
• FDM Group (Holdings) is estimated to be 34% undervalued based on current share price of UK£2.23
• Analyst price target for FDM is UK£4.23, which is 26% above our fair value estimate

How far off is FDM Group (Holdings) plc (LON:FDM) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Our free stock report includes 2 warning signs investors should be aware of before investing in FDM Group (Holdings). Read for free now.

The Method

We're 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 a stable growth rate. 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, 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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (£, Millions)	UK£21.3m	UK£22.2m	UK£26.7m	UK£26.5m	UK£26.6m	UK£26.9m	UK£27.3m	UK£27.8m	UK£28.3m	UK£28.9m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x1	Est @ -0.64%	Est @ 0.32%	Est @ 0.98%	Est @ 1.45%	Est @ 1.78%	Est @ 2.01%	Est @ 2.17%
Present Value (£, Millions) Discounted @ 8.9%	UK£19.6	UK£18.7	UK£20.7	UK£18.9	UK£17.4	UK£16.2	UK£15.1	UK£14.1	UK£13.2	UK£12.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£166m

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 (2.5%) 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 8.9%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = UK£29m× (1 + 2.5%) ÷ (8.9%– 2.5%) = UK£470m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£470m÷ ( 1 + 8.9%)¹⁰= UK£201m

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£367m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of UK£2.2, the company appears quite good value at a 34% 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.

Important Assumptions

We would point out that 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 FDM Group (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 8.9%, which is based on a levered beta of 1.231. 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 FDM Group (Holdings)

SWOT Analysis for FDM Group (Holdings)

Next Steps:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. What is the reason for the share price sitting below the intrinsic value? For FDM Group (Holdings), we've put together three additional items you should explore:

1. Risks: Case in point, we've spotted 2 warning signs for FDM Group (Holdings) you should be aware of.
2. Future Earnings: How does FDM'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. 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.