Calculating The Fair Value Of Classified Group (Holdings) Limited (HKG:8232)

Key Insights

• Classified Group (Holdings)'s estimated fair value is HK$0.032 based on 2 Stage Free Cash Flow to Equity
• With HK$0.029 share price, Classified Group (Holdings) appears to be trading close to its estimated fair value
• Peers of Classified Group (Holdings) are currently trading on average at a 38% premium

Today we will run through one way of estimating the intrinsic value of Classified Group (Holdings) Limited (HKG:8232) by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. 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.

View our latest analysis for Classified Group (Holdings)

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. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (HK$, Millions)	HK$1.00m	HK$1.11m	HK$1.20m	HK$1.28m	HK$1.34m	HK$1.39m	HK$1.44m	HK$1.48m	HK$1.52m	HK$1.56m
Growth Rate Estimate Source	Est @ 14.86%	Est @ 10.95%	Est @ 8.20%	Est @ 6.28%	Est @ 4.94%	Est @ 4.00%	Est @ 3.34%	Est @ 2.88%	Est @ 2.55%	Est @ 2.33%
Present Value (HK$, Millions) Discounted @ 11%	HK$0.9	HK$0.9	HK$0.9	HK$0.9	HK$0.8	HK$0.8	HK$0.7	HK$0.7	HK$0.6	HK$0.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$7.6m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 1.8%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = HK$1.6m× (1 + 1.8%) ÷ (11%– 1.8%) = HK$18m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$18m÷ ( 1 + 11%)¹⁰= HK$6.4m

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$14m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$0.03, the company appears about fair value at a 8.0% 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. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Classified 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 11%, which is based on a levered beta of 1.279. 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.

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess 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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Classified Group (Holdings), there are three further elements you should look at:

1. Risks: Every company has them, and we've spotted 2 warning signs for Classified Group (Holdings) (of which 1 doesn't sit too well with us!) you should know about.
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 Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.