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Does the share price for Tata Motors Limited (NSE:TATAMTRDVR) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value by taking the foreast future cash flows of the company and discounting them back to today’s value. I will be using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not August 2018 then I highly recommend you check out the latest calculation for Tata Motors by following the link below.

View our latest analysis for Tata Motors

The calculation

I’m 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. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.

5-year cash flow estimate

Present Value of 5-year Cash Flow (PVCF)= ₹164.84b

The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 7.7%. We discount this to today’s value at a cost of equity of 14.6%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = ₹102.47b × (1 + 7.7%) ÷ (14.6% – 7.7%) = ₹1.60t

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = ₹1.60t ÷ ( 1 + 14.6%)⁵ = ₹810.17b

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is ₹975.00b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of ₹153.25. Relative to the current share price of ₹139.2, the stock is about right, perhaps slightly undervalued at a 9.2% discount to what it is available for right now.

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Tata Motors 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 14.6%, which is based on a levered beta of 0.947. 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.