An Intrinsic Calculation For VIGO Photonics S.A. (WSE:VGO) Suggests It's 44% Undervalued

Key Insights

• VIGO Photonics' estimated fair value is zł1,017 based on 2 Stage Free Cash Flow to Equity
• VIGO Photonics' zł570 share price signals that it might be 44% undervalued
• When compared to theindustry average discount to fair value of 37%, VIGO Photonics' competitors seem to be trading at a lesser discount

Today we will run through one way of estimating the intrinsic value of VIGO Photonics S.A. (WSE:VGO) 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. There's really not all that much to it, even though it might appear quite complex.

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.

View our latest analysis for VIGO Photonics

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. 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, 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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF (PLN, Millions)	-zł31.3m	zł2.84m	zł27.6m	zł45.9m	zł61.1m	zł75.8m	zł89.3m	zł101.3m	zł111.8m	zł121.0m
Growth Rate Estimate Source	Analyst x1	Analyst x2	Analyst x2	Analyst x1	Est @ 33.08%	Est @ 24.11%	Est @ 17.83%	Est @ 13.43%	Est @ 10.35%	Est @ 8.20%
Present Value (PLN, Millions) Discounted @ 12%	-zł28.0	zł2.3	zł19.8	zł29.4	zł35.1	zł38.9	zł41.1	zł41.7	zł41.2	zł39.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = zł261m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 3.2%. We discount the terminal cash flows to today's value at a cost of equity of 12%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = zł121m× (1 + 3.2%) ÷ (12%– 3.2%) = zł1.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= zł1.5b÷ ( 1 + 12%)¹⁰= zł480m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is zł741m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of zł570, the company appears quite undervalued at a 44% 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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 VIGO Photonics 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 12%, which is based on a levered beta of 1.158. 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 VIGO Photonics

Next Steps:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching 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. What is the reason for the share price sitting below the intrinsic value? For VIGO Photonics, we've put together three essential aspects you should consider:

1. Risks: For example, we've discovered 2 warning signs for VIGO Photonics (1 makes us a bit uncomfortable!) that you should be aware of before investing here.
2. Future Earnings: How does VGO'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 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.