I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. In the first stage we need to estimate the cash flows to the business over the next five years. Seeing as no analyst estimates of free cash flow are available I have extrapolated the most recent reported free cash flow (FCF) based on the average annual revenue growth over the past five years. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow forecast
|Levered FCF ($, Millions)||$5.90||$6.23||$6.57||$6.93||$7.32|
|Source||Extrapolated @ (5.54%)||Extrapolated @ (5.54%)||Extrapolated @ (5.54%)||Extrapolated @ (5.54%)||Extrapolated @ (5.54%)|
|Present Value Discounted @ 10.94%||$5.32||$5.06||$4.81||$4.58||$4.35|
Present Value of 5-year Cash Flow (PVCF)= US$24.12m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.9%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 10.9%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$7.32m × (1 + 2.9%) ÷ (10.9% – 2.9%) = US$94.24m
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$94.24m ÷ ( 1 + 10.9%)5 = US$56.07m
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is US$80.18m. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of $8.16. Relative to the current share price of $6.64, the stock is about right, perhaps slightly undervalued at a 18.66% discount to what it is available for right now.
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 my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at ASV Holdings as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 10.9%, which is based on a levered beta of 1.134. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. For ASV, there are three fundamental aspects you should look at:
- Financial Health: Does ASV have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does ASV’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.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of ASV? 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 for every stock on the NASDAQ every 6 hours. If you want to find the calculation for other stocks just search here.