Estimating The Intrinsic Value Of Smartoptics Group AS (OB:SMOP)

Key Insights

• Smartoptics Group's estimated fair value is kr27.46 based on 2 Stage Free Cash Flow to Equity
• Current share price of kr22.30 suggests Smartoptics Group is potentially trading close to its fair value
• When compared to theindustry average discount to fair value of 35%, Smartoptics Group's competitors seem to be trading at a greater discount

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Smartoptics Group AS (OB:SMOP) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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 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 Smartoptics Group

Is Smartoptics Group 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. 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) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF ($, Millions)	US$5.00m	US$5.00m	US$8.00m	US$9.15m	US$10.1m	US$11.0m	US$11.7m	US$12.3m	US$12.9m	US$13.4m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x1	Est @ 14.32%	Est @ 10.77%	Est @ 8.28%	Est @ 6.54%	Est @ 5.32%	Est @ 4.47%	Est @ 3.87%
Present Value ($, Millions) Discounted @ 6.4%	US$4.7	US$4.4	US$6.6	US$7.1	US$7.4	US$7.5	US$7.6	US$7.5	US$7.3	US$7.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$67m

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 (2.5%) 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 6.4%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = US$13m× (1 + 2.5%) ÷ (6.4%– 2.5%) = US$346m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$346m÷ ( 1 + 6.4%)¹⁰= US$186m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$253m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of kr22.3, the company appears about fair value at a 19% 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.

Important Assumptions

We would point out that 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 Smartoptics Group 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 6.4%, which is based on a levered beta of 0.913. 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 Smartoptics Group

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. 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 Smartoptics Group, we've compiled three additional factors you should further research:

1. Risks: As an example, we've found 1 warning sign for Smartoptics Group that you need to consider before investing here.
2. Future Earnings: How does SMOP'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 Norwegian 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.