Volvo Car AB (publ.)'s (STO:VOLCAR B) Intrinsic Value Is Potentially 87% Above Its Share Price

Key Insights

• Volvo Car AB (publ.)'s estimated fair value is kr71.59 based on 2 Stage Free Cash Flow to Equity
• Volvo Car AB (publ.) is estimated to be 47% undervalued based on current share price of kr38.20
• Analyst price target for VOLCAR B is kr45.00 which is 37% below our fair value estimate

How far off is Volvo Car AB (publ.) (STO:VOLCAR B) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Volvo Car AB (publ.)

Step By Step Through The Calculation

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. To begin with, we have to get estimates of 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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (SEK, Millions)	-kr2.40b	kr3.11b	kr9.52b	kr13.6b	kr17.7b	kr21.5b	kr24.7b	kr27.4b	kr29.5b	kr31.1b
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x1	Est @ 42.76%	Est @ 30.13%	Est @ 21.29%	Est @ 15.11%	Est @ 10.78%	Est @ 7.74%	Est @ 5.62%
Present Value (SEK, Millions) Discounted @ 10%	-kr2.2k	kr2.6k	kr7.1k	kr9.2k	kr10.9k	kr12.0k	kr12.5k	kr12.6k	kr12.3k	kr11.8k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = kr89b

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 0.7%. We discount the terminal cash flows to today's value at a cost of equity of 10%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = kr31b× (1 + 0.7%) ÷ (10%– 0.7%) = kr329b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= kr329b÷ ( 1 + 10%)¹⁰= kr125b

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 kr213b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of kr38.2, the company appears quite good value at a 47% 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.

The 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 Volvo Car AB (publ.) 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 10%, which is based on a levered beta of 1.906. 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 Volvo Car AB (publ.)

Looking Ahead:

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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Why is the intrinsic value higher than the current share price? For Volvo Car AB (publ.), we've compiled three essential factors you should further research:

1. Risks: For instance, we've identified 1 warning sign for Volvo Car AB (publ.) that you should be aware of.
2. Future Earnings: How does VOLCAR B'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 Swedish 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.