Estimating The Fair Value Of Red Dev Studio S.A. (WSE:RDS)

Key Insights

• The projected fair value for Red Dev Studio is zł1.17 based on 2 Stage Free Cash Flow to Equity
• Red Dev Studio's zł1.04 share price indicates it is trading at similar levels as its fair value estimate
• Peers of Red Dev Studio are currently trading on average at a 669% premium

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Red Dev Studio S.A. (WSE:RDS) as an investment opportunity 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. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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.

Check out our latest analysis for Red Dev Studio

Crunching The Numbers

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. 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.

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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (PLN, Millions)	zł1.55m	zł2.03m	zł2.49m	zł2.92m	zł3.31m	zł3.65m	zł3.96m	zł4.24m	zł4.50m	zł4.75m
Growth Rate Estimate Source	Est @ 42.70%	Est @ 31.05%	Est @ 22.90%	Est @ 17.20%	Est @ 13.20%	Est @ 10.40%	Est @ 8.45%	Est @ 7.08%	Est @ 6.12%	Est @ 5.45%
Present Value (PLN, Millions) Discounted @ 9.5%	zł1.4	zł1.7	zł1.9	zł2.0	zł2.1	zł2.1	zł2.1	zł2.1	zł2.0	zł1.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = zł19m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 3.9%. We discount the terminal cash flows to today's value at a cost of equity of 9.5%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = zł4.7m× (1 + 3.9%) ÷ (9.5%– 3.9%) = zł88m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= zł88m÷ ( 1 + 9.5%)¹⁰= zł36m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is zł55m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of zł1.0, the company appears about fair value at a 11% 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

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Red Dev Studio 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 9.5%, which is based on a levered beta of 1.088. 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 Red Dev Studio

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. It's not possible to obtain a foolproof valuation with a DCF model. 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 Red Dev Studio, we've put together three pertinent elements you should consider:

1. Risks: Take risks, for example - Red Dev Studio has 6 warning signs (and 5 which are significant) we think you should know about.
2. 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!
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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the WSE every day. If you want to find the calculation for other stocks 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.