Today we will run through one way of estimating the intrinsic value of Shenzhen Mingwah Aohan High Technology Corporation Limited (HKG:8301) by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
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.
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 start off with, we need to estimate 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, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
|Levered FCF (CN¥, Millions)||CN¥1.88m||CN¥2.17m||CN¥2.42m||CN¥2.62m||CN¥2.79m||CN¥2.93m||CN¥3.04m||CN¥3.14m||CN¥3.22m||CN¥3.30m|
|Growth Rate Estimate Source||Est @ 21.64%||Est @ 15.6%||Est @ 11.37%||Est @ 8.41%||Est @ 6.34%||Est @ 4.89%||Est @ 3.88%||Est @ 3.17%||Est @ 2.67%||Est @ 2.32%|
|Present Value (CN¥, Millions) Discounted @ 12%||CN¥1.7||CN¥1.7||CN¥1.7||CN¥1.7||CN¥1.6||CN¥1.5||CN¥1.4||CN¥1.3||CN¥1.2||CN¥1.1|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥14m
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 1.5%. We discount the terminal cash flows to today's value at a cost of equity of 12%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = CN¥3.3m× (1 + 1.5%) ÷ (12%– 1.5%) = CN¥33m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥33m÷ ( 1 + 12%)10= CN¥11m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CN¥25m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of HK$0.04, the company appears about fair value at a 2.2% 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.
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. 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 Shenzhen Mingwah Aohan High Technology 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 12%, which is based on a levered beta of 1.626. 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.
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Shenzhen Mingwah Aohan High Technology, we've put together three relevant factors you should look at:
- Risks: Case in point, we've spotted 4 warning signs for Shenzhen Mingwah Aohan High Technology you should be aware of, and 3 of them don't sit too well with us.
- 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!
- 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. 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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