Today we’ll do a simple run through of a valuation method used to estimate the attractiveness of Gix Internet Ltd (TLV:GIX) as an investment opportunity by taking the expected future cash flows and discounting them to today’s value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they’re fairly easy to follow.
We generally believe that a company’s value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
Is Gix Internet fairly valued?
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company’s last reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:
10-year free cash flow (FCF) estimate
|Levered FCF (₪, Millions)||₪4.20m||₪3.49m||₪3.10m||₪2.87m||₪2.73m||₪2.66m||₪2.62m||₪2.61m||₪2.61m||₪2.63m|
|Growth Rate Estimate Source||Est @ -24.82%||Est @ -16.87%||Est @ -11.3%||Est @ -7.41%||Est @ -4.68%||Est @ -2.77%||Est @ -1.44%||Est @ -0.5%||Est @ 0.15%||Est @ 0.61%|
|Present Value (₪, Millions) Discounted @ 8.1%||₪3.9||₪3.0||₪2.5||₪2.1||₪1.9||₪1.7||₪1.5||₪1.4||₪1.3||₪1.2|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₪20m
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.7%. We discount the terminal cash flows to today’s value at a cost of equity of 8.1%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = ₪2.6m× (1 + 1.7%) ÷ (8.1%– 1.7%) = ₪42m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₪42m÷ ( 1 + 8.1%)10= ₪19m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₪39m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of ₪1.4, the company appears about fair value at a 4.4% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula – garbage in, garbage out.
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 these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company’s future capital requirements, so it does not give a full picture of a company’s potential performance. Given that we are looking at Gix Internet as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we’ve used 8.1%, which is based on a levered beta of 1.019. Beta is a measure of a stock’s volatility, compared to the market as a whole. We get our beta from the industry average beta of globally 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. It’s not possible to obtain a foolproof valuation with a DCF model. Preferably you’d apply different cases and assumptions and see how they would impact the company’s valuation. For example, changes in the company’s cost of equity or the risk free rate can significantly impact the valuation. For Gix Internet, we’ve put together three fundamental items you should further examine:
- Risks: Consider for instance, the ever-present spectre of investment risk. We’ve identified 2 warning signs with Gix Internet (at least 1 which is significant) , and understanding these should be part of your investment process.
- Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
- Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts’ top stock picks to find out what they feel might have an attractive future outlook!
PS. Simply Wall St updates its DCF calculation for every Israeli stock every day, so if you want to find the intrinsic value of any other stock just search here.
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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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