Calculating The Intrinsic Value Of Zhejiang United Investment Holdings Group Limited (HKG:8366)

Key Insights

• The projected fair value for Zhejiang United Investment Holdings Group is HK$0.028 based on 2 Stage Free Cash Flow to Equity
• With HK$0.034 share price, Zhejiang United Investment Holdings Group appears to be trading close to its estimated fair value
• When compared to theindustry average discount of -92%, Zhejiang United Investment Holdings Group's competitors seem to be trading at a greater premium to fair value

In this article we are going to estimate the intrinsic value of Zhejiang United Investment Holdings Group Limited (HKG:8366) by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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.

View our latest analysis for Zhejiang United Investment Holdings Group

The Model

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. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (HK$, Millions)	HK$3.12m	HK$3.32m	HK$3.48m	HK$3.62m	HK$3.74m	HK$3.85m	HK$3.95m	HK$4.04m	HK$4.12m	HK$4.20m
Growth Rate Estimate Source	Est @ 8.30%	Est @ 6.34%	Est @ 4.96%	Est @ 3.99%	Est @ 3.32%	Est @ 2.84%	Est @ 2.51%	Est @ 2.28%	Est @ 2.12%	Est @ 2.00%
Present Value (HK$, Millions) Discounted @ 9.6%	HK$2.8	HK$2.8	HK$2.6	HK$2.5	HK$2.4	HK$2.2	HK$2.1	HK$1.9	HK$1.8	HK$1.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$23m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 1.7%. We discount the terminal cash flows to today's value at a cost of equity of 9.6%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = HK$4.2m× (1 + 1.7%) ÷ (9.6%– 1.7%) = HK$55m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$55m÷ ( 1 + 9.6%)¹⁰= HK$22m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is HK$45m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of HK$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.

The Assumptions

Now 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 Zhejiang United Investment Holdings 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 9.6%, which is based on a levered beta of 1.125. 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 Zhejiang United Investment Holdings Group

Next Steps:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Zhejiang United Investment Holdings Group, we've put together three further items you should further research:

1. Risks: Take risks, for example - Zhejiang United Investment Holdings Group has 4 warning signs we think you should be aware of.
2. 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!
3. Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SEHK 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.