Is Gold Circuit Electronics Ltd. (TPE:2368) Trading At A 40% Discount?

Does the March share price for Gold Circuit Electronics Ltd. (TPE:2368) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Gold Circuit Electronics

What's the estimated valuation?

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 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, 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) forecast

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF (NT$, Millions)	NT$2.31b	NT$2.93b	NT$3.38b	NT$3.76b	NT$4.06b	NT$4.30b	NT$4.48b	NT$4.63b	NT$4.75b	NT$4.85b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 15.46%	Est @ 11.07%	Est @ 8%	Est @ 5.85%	Est @ 4.34%	Est @ 3.29%	Est @ 2.55%	Est @ 2.04%
Present Value (NT$, Millions) Discounted @ 8.7%	NT$2.1k	NT$2.5k	NT$2.6k	NT$2.7k	NT$2.7k	NT$2.6k	NT$2.5k	NT$2.4k	NT$2.2k	NT$2.1k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = NT$24b

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 0.8%. We discount the terminal cash flows to today's value at a cost of equity of 8.7%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = NT$4.8b× (1 + 0.8%) ÷ (8.7%– 0.8%) = NT$62b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= NT$62b÷ ( 1 + 8.7%)¹⁰= NT$27b

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$51b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of NT$57.2, the company appears quite undervalued at a 40% discount to where the stock price trades currently. 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.

Important 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 Gold Circuit Electronics 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 8.7%, which is based on a levered beta of 1.284. 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:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for 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. Can we work out why the company is trading at a discount to intrinsic value? For Gold Circuit Electronics, we've compiled three additional factors you should further research:

1. Risks: Every company has them, and we've spotted 1 warning sign for Gold Circuit Electronics you should know about.
2. Future Earnings: How does 2368'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 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!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the TSEC 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. 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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