Does the share price for Interserve plc (LSE:IRV) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value using the discounted cash flow (DCF) method. 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 April 2018 then I highly recommend you check out the latest calculation for Interserve here.
What’s the value?
I will be using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. Firstly, I use the analyst consensus forecast of IRV’s levered free cash flow (FCF) over the next five years and discounted these figures at the rate of 18.51%. 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 UK£110.10M. Want to know how I arrived at this number? Read our detailed analysis here.
Above is a visual representation of how IRV’s top and bottom lines are expected to move in the future, which should give you an idea of IRV’s outlook. Then, I calculate the terminal value, which is the business’s cash flow after the first stage. It’s appropriate to use the 10-year government bond rate of 2.8% as the perpetual 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 UK£111.37M.
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is UK£221.47M. The last step is to then divide the equity value by the number of shares outstanding. This results in an intrinsic value of £1.52, which, compared to the current share price of £0.8535, we see that Interserve is quite good value at a 44.03% discount to what it is available for right now.
Next Steps:
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For IRV, I’ve put together three important factors you should look at:
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Financial Health: Does IRV 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 IRV’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 IRV? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!