Calculating The Intrinsic Value Of Sterling and Wilson Solar Limited (NSE:SWSOLAR)

In this article we are going to estimate the intrinsic value of Sterling and Wilson Solar Limited (NSE:SWSOLAR) by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Sterling and Wilson Solar

Is Sterling and Wilson Solar fairly valued?

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. 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.

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

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (₹, Millions)	₹4.53b	₹5.02b	₹5.51b	₹6.00b	₹6.50b	₹7.01b	₹7.55b	₹8.11b	₹8.70b	₹9.33b
Growth Rate Estimate Source	Est @ 12.63%	Est @ 10.93%	Est @ 9.74%	Est @ 8.9%	Est @ 8.32%	Est @ 7.91%	Est @ 7.63%	Est @ 7.43%	Est @ 7.29%	Est @ 7.19%
Present Value (₹, Millions) Discounted @ 17%	₹3.9k	₹3.7k	₹3.5k	₹3.2k	₹3.0k	₹2.8k	₹2.6k	₹2.4k	₹2.2k	₹2.0k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹29b

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 7.0%. We discount the terminal cash flows to today's value at a cost of equity of 17%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = ₹9.3b× (1 + 7.0%) ÷ (17%– 7.0%) = ₹104b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹104b÷ ( 1 + 17%)¹⁰= ₹22b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹52b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of ₹279, the company appears about fair value at a 13% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

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 Sterling and Wilson Solar 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 17%, which is based on a levered beta of 1.139. 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:

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. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" 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 Sterling and Wilson Solar, there are three fundamental items you should assess:

1. Risks: Case in point, we've spotted 6 warning signs for Sterling and Wilson Solar you should be aware of, and 1 of them makes us a bit uncomfortable.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SWSOLAR's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
3. 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!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NSEI 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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