Estimating The Intrinsic Value Of Great World Company Holdings Ltd (HKG:8003)

Key Insights

• The projected fair value for Great World Company Holdings is HK$0.27 based on 2 Stage Free Cash Flow to Equity
• Great World Company Holdings' HK$0.30 share price indicates it is trading at similar levels as its fair value estimate
• Great World Company Holdings' peers seem to be trading at a higher premium to fair value based onthe industry average of -4,636%

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Great World Company Holdings Ltd (HKG:8003) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Great World Company Holdings

The Method

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (HK$, Millions)	HK$7.56m	HK$7.93m	HK$8.25m	HK$8.53m	HK$8.79m	HK$9.03m	HK$9.26m	HK$9.48m	HK$9.69m	HK$9.91m
Growth Rate Estimate Source	Est @ 6.11%	Est @ 4.89%	Est @ 4.04%	Est @ 3.44%	Est @ 3.02%	Est @ 2.72%	Est @ 2.52%	Est @ 2.38%	Est @ 2.27%	Est @ 2.20%
Present Value (HK$, Millions) Discounted @ 11%	HK$6.8	HK$6.4	HK$6.0	HK$5.6	HK$5.2	HK$4.8	HK$4.4	HK$4.1	HK$3.7	HK$3.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = HK$50m

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 11%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = HK$9.9m× (1 + 2.0%) ÷ (11%– 2.0%) = HK$111m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= HK$111m÷ ( 1 + 11%)¹⁰= HK$38m

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$89m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of HK$0.3, 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

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Great World Company 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 1.665. 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 Great World Company Holdings

Moving On:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. For Great World Company Holdings, there are three fundamental elements you should assess:

1. Risks: Be aware that Great World Company Holdings is showing 3 warning signs in our investment analysis , and 2 of those are potentially serious...
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 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. Simply Wall St updates its DCF calculation for every Hong Kong 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.