A Look At The Fair Value Of Tokai Lease Co.,Ltd. (TSE:9761)

Key Insights

• Tokai LeaseLtd's estimated fair value is JP¥2,134 based on Dividend Discount Model
• Tokai LeaseLtd's JP¥1,822 share price indicates it is trading at similar levels as its fair value estimate
• Tokai LeaseLtd's peers seem to be trading at a higher discount to fair value based on the industry average of 18%

How far off is Tokai Lease Co.,Ltd. (TSE:9761) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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Step By Step Through The Calculation

We have to calculate the value of Tokai LeaseLtd slightly differently to other stocks because it is a commercial services company. In this approach dividends per share (DPS) are used, as free cash flow is difficult to estimate and often not reported by analysts. Unless a company pays out the majority of its FCF as a dividend, this method will typically underestimate the value of the stock. We use the Gordon Growth Model, which assumes dividend will grow into perpetuity at a rate that can be sustained. For a number of reasons a very conservative growth rate is used that cannot exceed that of a company's Gross Domestic Product (GDP). In this case we used the 5-year average of the 10-year government bond yield (0.4%). The expected dividend per share is then discounted to today's value at a cost of equity of 5.1%. Relative to the current share price of JP¥1.8k, the company appears about fair value at a 15% 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.

Value Per Share = Expected Dividend Per Share / (Discount Rate - Perpetual Growth Rate)

= JP¥100.0 / (5.1% – 0.4%)

= JP¥2.1k

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 Tokai LeaseLtd 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 5.1%, which is based on a levered beta of 0.889. 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.

Check out our latest analysis for Tokai LeaseLtd

SWOT Analysis for Tokai LeaseLtd

Moving On:

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 example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Tokai LeaseLtd, there are three relevant aspects you should further examine:

1. Risks: For instance, we've identified 4 warning signs for Tokai LeaseLtd (1 is concerning) you should be aware of.
2. 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!
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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the TSE every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.