Estimating The Fair Value Of Firstlogic,Inc. (TSE:6037)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, FirstlogicInc fair value estimate is JP¥738
• With JP¥636 share price, FirstlogicInc appears to be trading close to its estimated fair value
• When compared to theindustry average discount to fair value of 6.9%, FirstlogicInc's competitors seem to be trading at a lesser discount

Today we will run through one way of estimating the intrinsic value of Firstlogic,Inc. (TSE:6037) by taking the expected future cash flows and discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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 FirstlogicInc

The Method

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. 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) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (¥, Millions)	JP¥757.7m	JP¥787.8m	JP¥810.3m	JP¥827.2m	JP¥839.9m	JP¥849.5m	JP¥857.0m	JP¥863.0m	JP¥867.9m	JP¥872.0m
Growth Rate Estimate Source	Est @ 5.56%	Est @ 3.97%	Est @ 2.86%	Est @ 2.08%	Est @ 1.53%	Est @ 1.15%	Est @ 0.88%	Est @ 0.70%	Est @ 0.57%	Est @ 0.47%
Present Value (¥, Millions) Discounted @ 5.5%	JP¥718	JP¥708	JP¥690	JP¥667	JP¥642	JP¥615	JP¥588	JP¥561	JP¥535	JP¥509

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥6.2b

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 0.3%. We discount the terminal cash flows to today's value at a cost of equity of 5.5%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = JP¥872m× (1 + 0.3%) ÷ (5.5%– 0.3%) = JP¥17b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥17b÷ ( 1 + 5.5%)¹⁰= JP¥9.7b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is JP¥16b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of JP¥636, the company appears about fair value at a 14% 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.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 FirstlogicInc 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 5.5%, which is based on a levered beta of 1.057. 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 FirstlogicInc

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. 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 FirstlogicInc, we've put together three essential items you should look at:

1. Risks: For example, we've discovered 1 warning sign for FirstlogicInc that you should be aware of before investing here.
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 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 Japanese 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.