Calculating The Fair Value Of Dimerco Data System Corporation (GTSM:5403)

Today we will run through one way of estimating the intrinsic value of Dimerco Data System Corporation (GTSM:5403) by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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.

See our latest analysis for Dimerco Data System

The method

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. 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

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (NT$, Millions)	NT$334.9m	NT$293.5m	NT$268.9m	NT$253.9m	NT$244.7m	NT$239.2m	NT$236.1m	NT$234.6m	NT$234.2m	NT$234.6m
Growth Rate Estimate Source	Est @ -18.07%	Est @ -12.37%	Est @ -8.38%	Est @ -5.58%	Est @ -3.63%	Est @ -2.26%	Est @ -1.3%	Est @ -0.63%	Est @ -0.16%	Est @ 0.17%
Present Value (NT$, Millions) Discounted @ 8.9%	NT$308	NT$247	NT$208	NT$180	NT$160	NT$143	NT$130	NT$118	NT$109	NT$99.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NT$1.7b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (0.9%) 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 8.9%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = NT$235m× (1 + 0.9%) ÷ (8.9%– 0.9%) = NT$3.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= NT$3.0b÷ ( 1 + 8.9%)¹⁰= NT$1.3b

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$3.0b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of NT$54.4, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

The assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Dimerco Data System 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 8.9%, which is based on a levered beta of 1.121. 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.

Next Steps:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Dimerco Data System, we've compiled three relevant aspects you should assess:

1. Risks: As an example, we've found 1 warning sign for Dimerco Data System that you need to consider before investing here.
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. Simply Wall St updates its DCF calculation for every Taiwanese 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. 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.
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