A Look At The Fair Value Of Image Scan Holdings Plc (LON:IGE)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Image Scan Holdings fair value estimate is UK£0.027
• Image Scan Holdings' UK£0.029 share price indicates it is trading at similar levels as its fair value estimate
• When compared to theindustry average discount of -21%, Image Scan Holdings' competitors seem to be trading at a greater premium to fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Image Scan Holdings Plc (LON:IGE) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. There's really not all that much to it, even though it might appear quite complex.

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.

Check out our latest analysis for Image Scan Holdings

The Model

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, 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£200.0k	UK£202.2k	UK£205.1k	UK£208.4k	UK£212.1k	UK£216.1k	UK£220.3k	UK£224.7k	UK£229.2k	UK£233.9k
Growth Rate Estimate Source	Analyst x1	Est @ 1.12%	Est @ 1.42%	Est @ 1.62%	Est @ 1.77%	Est @ 1.87%	Est @ 1.94%	Est @ 1.99%	Est @ 2.03%	Est @ 2.05%
Present Value (£, Millions) Discounted @ 7.4%	UK£0.2	UK£0.2	UK£0.2	UK£0.2	UK£0.1	UK£0.1	UK£0.1	UK£0.1	UK£0.1	UK£0.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£1.5m

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 (2.1%) 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 7.4%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = UK£234k× (1 + 2.1%) ÷ (7.4%– 2.1%) = UK£4.5m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£4.5m÷ ( 1 + 7.4%)¹⁰= UK£2.2m

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£3.7m. 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£0.03, the company appears around fair value at the time of writing. 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

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 Image Scan 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 7.4%, which is based on a levered beta of 1.094. 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.

SWOT Analysis for Image Scan Holdings

Moving On:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Image Scan Holdings, there are three additional elements you should explore:

1. Risks: We feel that you should assess the 3 warning signs for Image Scan Holdings (2 make us uncomfortable!) we've flagged before making an investment in the company.
2. Future Earnings: How does IGE'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. 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.