In This Article:
Today I will be providing a simple run-through of the discounted cash flows (DCF) method to estimate the attractiveness of NagaCorp Ltd (SEHK:3918) as an investment opportunity. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this after May 2018 then I highly recommend you check out the latest calculation for NagaCorp here.
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. To begin, I took the analyst consensus estimates of 3918’s levered free cash flow (FCF) over the next five years and discounted these values at the cost of equity of 13.74%. When estimates weren’t available, I’ve extrapolated the average annual growth rate over the previous five years, capped at a reasonable level. This resulted in a present value of 5-year cash flow of US$1.37B. Keen to know how I calculated this value? Check out our detailed analysis here.
In the visual above, we see how how 3918’s earnings are expected to move in the future, which should give you some color on 3918’s outlook. Secondly, I determine the terminal value, which is the business’s cash flow after the first stage. I think it’s suitable to use the 10-year government bond rate of 2.8% as the stable growth rate, which is rightly below GDP growth, but more towards the conservative side. After discounting the terminal value back five years, the present value becomes US$2.51B.
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$3.87B. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value of HK$7.01, which, compared to the current share price of HK$7.57, we find that NagaCorp is fair value, maybe slightly overvalued and not available at a discount at this time.
Next Steps:
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company.
For 3918, I’ve put together three important aspects you should further examine:
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Financial Health: Does 3918 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.
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Future Earnings: How does 3918’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.
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Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of 3918? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!