Calculating The Fair Value Of The Hi-Tech Gears Limited (NSE:HITECHGEAR)

Key Insights

• Hi-Tech Gears' estimated fair value is ₹211 based on 2 Stage Free Cash Flow to Equity
• Current share price of ₹231 suggests Hi-Tech Gears is trading close to its fair value
• Industry average of 367% suggests Hi-Tech Gears' peers are currently trading at a higher premium

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of The Hi-Tech Gears Limited (NSE:HITECHGEAR) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Hi-Tech Gears

What's The Estimated Valuation?

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. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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 (₹, Millions)	₹594.2m	₹664.7m	₹733.5m	₹801.5m	₹869.9m	₹939.5m	₹1.01b	₹1.09b	₹1.16b	₹1.25b
Growth Rate Estimate Source	Est @ 14.04%	Est @ 11.87%	Est @ 10.34%	Est @ 9.28%	Est @ 8.53%	Est @ 8.01%	Est @ 7.64%	Est @ 7.39%	Est @ 7.21%	Est @ 7.08%
Present Value (₹, Millions) Discounted @ 24%	₹480	₹434	₹387	₹342	₹300	₹262	₹228	₹198	₹172	₹148

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹3.0b

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 6.8%. We discount the terminal cash flows to today's value at a cost of equity of 24%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = ₹1.2b× (1 + 6.8%) ÷ (24%– 6.8%) = ₹7.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹7.9b÷ ( 1 + 24%)¹⁰= ₹937m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹3.9b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ₹231, 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. 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 Hi-Tech Gears 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 24%, which is based on a levered beta of 1.864. 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 Hi-Tech Gears

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Hi-Tech Gears, we've put together three important elements you should assess:

1. Risks: For example, we've discovered 6 warning signs for Hi-Tech Gears (2 are concerning!) that you should be aware of before investing here.
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. Simply Wall St updates its DCF calculation for every Indian 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.