Today I will be providing a simple run-through of the discounted cash flows (DCF) method to estimate the attractiveness of Proactis Holdings Plc (AIM:PHD) as an investment opportunity. If you want to learn more about this method, the basis for my calculations can be found in detail in the Simply Wall St analysis model. If you are reading this after December 2017 then I highly recommend you check out the latest calculation for Proactis Holdings here.
Is PHD fairly valued?
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 estimates of PHD’s levered free cash flow (FCF) over the next five years and discounted these values at the rate of 8.3%. 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 £39.6M. Want to understand how I arrived at this number? Take a look at our detailed analysis here.
Above is a visual representation of how PHD’s earnings are expected to move in the future, which should give you an idea of PHD’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 stable growth rate, which is rightly below GDP growth, but more towards the conservative side. The present value of the terminal value after discounting it back five years is £167.7M.
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 £207.3M. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value of £2.23, which, compared to the current share price of £1.715, we see that Proactis Holdings is about right, perhaps slightly undervalued at a 23.20% 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 PHD, I’ve put together three relevant aspects you should further research:
PS. The Simply Wall St app conducts a discounted cash flow for every stock on the AIM every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.