Stock Analysis

# Are Telechips Inc. (KOSDAQ:054450) Investors Paying Above The Intrinsic Value?

Today we will run through one way of estimating the intrinsic value of Telechips Inc. (KOSDAQ:054450) by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing 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.

See our latest analysis for Telechips

### The calculation

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. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

#### 10-year free cash flow (FCF) estimate

 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Levered FCF (₩, Millions) ₩35.0b ₩20.0b ₩13.2b ₩10.2b ₩8.68b ₩7.88b ₩7.46b ₩7.26b ₩7.20b ₩7.24b Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ -34.04% Est @ -22.73% Est @ -14.8% Est @ -9.26% Est @ -5.38% Est @ -2.66% Est @ -0.76% Est @ 0.57% Present Value (₩, Millions) Discounted @ 11% ₩31.4k ₩16.1k ₩9.6k ₩6.6k ₩5.1k ₩4.1k ₩3.5k ₩3.1k ₩2.7k ₩2.5k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₩85b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (3.7%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 11%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = ₩7.2b× (1 + 3.7%) ÷ (11%– 3.7%) = ₩99b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₩99b÷ ( 1 + 11%)10= ₩34b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₩119b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ₩12k, the company appears slightly overvalued 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.

### Important 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 Telechips 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 11%, which is based on a levered beta of 1.279. 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.

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. Can we work out why the company is trading at a premium to intrinsic value? For Telechips, there are three pertinent aspects you should assess:

1. Risks: We feel that you should assess the 2 warning signs for Telechips we've flagged before making an investment in the company.
2. Future Earnings: How does A054450'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the KOSDAQ every day. If you want to find the calculation for other stocks just search here.

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### Valuation is complex, but we're here to simplify it.

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