Calculating The Intrinsic Value Of Sunplus Technology Company Limited (TWSE:2401)

Key Insights

• Sunplus Technology's estimated fair value is NT$32.35 based on 2 Stage Free Cash Flow to Equity
• Current share price of NT$34.40 suggests Sunplus Technology is potentially trading close to its fair value
• When compared to theindustry average discount of -66%, Sunplus Technology's competitors seem to be trading at a greater premium to fair value

Today we will run through one way of estimating the intrinsic value of Sunplus Technology Company Limited (TWSE:2401) by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. 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 want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for Sunplus Technology

Crunching The Numbers

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. 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) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (NT$, Millions)	NT$1.22b	NT$1.31b	NT$1.38b	NT$1.43b	NT$1.48b	NT$1.51b	NT$1.54b	NT$1.57b	NT$1.59b	NT$1.61b
Growth Rate Estimate Source	Est @ 9.56%	Est @ 6.98%	Est @ 5.18%	Est @ 3.91%	Est @ 3.03%	Est @ 2.41%	Est @ 1.98%	Est @ 1.68%	Est @ 1.46%	Est @ 1.32%
Present Value (NT$, Millions) Discounted @ 8.5%	NT$1.1k	NT$1.1k	NT$1.1k	NT$1.0k	NT$982	NT$927	NT$872	NT$817	NT$764	NT$714

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NT$9.4b

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 (1.0%) 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 8.5%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = NT$1.6b× (1 + 1.0%) ÷ (8.5%– 1.0%) = NT$22b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= NT$22b÷ ( 1 + 8.5%)¹⁰= NT$9.6b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is NT$19b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of NT$34.4, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Sunplus Technology 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 8.5%, which is based on a levered beta of 1.370. 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 Sunplus Technology

Looking Ahead:

Although the valuation of a company is important, 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 Sunplus Technology, there are three relevant elements you should look at:

1. Risks: For instance, we've identified 2 warning signs for Sunplus Technology (1 doesn't sit too well with us) you should be aware of.
2. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
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 TWSE 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com