Calculating The Intrinsic Value Of Legend Strategy International Holdings Group Company Limited (HKG:1355)

In this article we are going to estimate the intrinsic value of Legend Strategy International Holdings Group Company Limited (HKG:1355) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.

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. 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 Legend Strategy International Holdings Group

Step by step through the calculation

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (HK$, Millions)	HK$13.6m	HK$14.2m	HK$14.6m	HK$15.0m	HK$15.4m	HK$15.7m	HK$16.0m	HK$16.3m	HK$16.5m	HK$16.8m
Growth Rate Estimate Source	Est @ 4.97%	Est @ 3.93%	Est @ 3.2%	Est @ 2.7%	Est @ 2.34%	Est @ 2.09%	Est @ 1.92%	Est @ 1.79%	Est @ 1.71%	Est @ 1.65%
Present Value (HK$, Millions) Discounted @ 11%	HK$12.3	HK$11.5	HK$10.8	HK$10.0	HK$9.2	HK$8.5	HK$7.8	HK$7.2	HK$6.6	HK$6.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$90m

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 1.5%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = HK$17m× (1 + 1.5%) ÷ (11%– 1.5%) = HK$185m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$185m÷ ( 1 + 11%)¹⁰= HK$67m

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 HK$157m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of HK$0.3, the company appears about fair value at a 2.8% 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.

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 Legend Strategy International 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 11%, which is based on a levered beta of 1.506. 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.

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Legend Strategy International Holdings Group, we've compiled three fundamental factors you should further examine:

1. Risks: You should be aware of the 2 warning signs for Legend Strategy International Holdings Group we've uncovered before considering an investment in the company.
2. 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!
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. 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.
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