Calculating The Intrinsic Value Of Oracle Financial Services Software Limited (NSE:OFSS)

Key Insights

• Oracle Financial Services Software's estimated fair value is ₹2.8k based on 2 Stage Free Cash Flow to Equity
• Current share price of ₹3.1k suggests Oracle Financial Services Software is trading close to its fair value
• Industry average of 482% suggests Oracle Financial Services Software's peers are currently trading at a higher premium

Does the January share price for Oracle Financial Services Software Limited (NSE:OFSS) reflect what it's really worth? Today, we will estimate the stock's intrinsic value 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. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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 want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for Oracle Financial Services Software

What's The Estimated Valuation?

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. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (₹, Millions)	₹20.1b	₹22.4b	₹24.4b	₹26.4b	₹28.5b	₹30.7b	₹32.9b	₹35.2b	₹37.7b	₹40.4b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 8.91%	Est @ 8.27%	Est @ 7.83%	Est @ 7.52%	Est @ 7.30%	Est @ 7.15%	Est @ 7.04%	Est @ 6.96%
Present Value (₹, Millions) Discounted @ 16%	₹17.3k	₹16.7k	₹15.8k	₹14.7k	₹13.7k	₹12.8k	₹11.8k	₹11.0k	₹10.1k	₹9.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹133b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 6.8%. We discount the terminal cash flows to today's value at a cost of equity of 16%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = ₹40b× (1 + 6.8%) ÷ (16%– 6.8%) = ₹483b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹483b÷ ( 1 + 16%)¹⁰= ₹112b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is ₹245b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of ₹3.1k, the company appears around fair value at the time of writing. 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. 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 Oracle Financial Services Software 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 16%, which is based on a levered beta of 0.983. 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 Oracle Financial Services Software

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess 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 Oracle Financial Services Software, we've put together three relevant aspects you should consider:

1. Risks: Case in point, we've spotted 1 warning sign for Oracle Financial Services Software you should be aware of.
2. Future Earnings: How does OFSS's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
3. 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!

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.