Today we are going to do a simple overview of a valuation method used to estimate the attractiveness of China Overseas Land & Investment Limited (HKG:688) as an investment opportunity by taking the flows expected future cash flows of the business and discounting them from today. assess. One way to do this is to use the discounted cash flow (DCF) model. There really isn’t much to do, although it may seem quite complex.
Remember though that there are many ways to estimate the value of a business and a DCF is just one method. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
Check out our latest analysis for China Overseas Land & Investment
Are lands and overseas investments in China properly valued?
We have to calculate the value of China Overseas Land & Investment slightly differently than other stocks because it is a real estate company. In this approach, dividends per share (DPS) are used, because free cash flow is difficult to estimate and often not reported by analysts. Unless a company pays the majority of its FCF as a dividend, this method will generally underestimate the value of the stock. We use Gordon’s growth model, which assumes that the dividend will grow in perpetuity at a rate that can be sustained. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a company’s Gross Domestic Product (GDP). In this case, we used the 5-year average of the 10-year government bond yield (1.5%). The expected dividend per share is then discounted to its present value at a cost of equity of 8.1%. Compared to the current share price of HK$21.9, the company appears around fair value at the time of writing. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in a different galaxy. Keep that in mind.
Value per share = Expected dividend per share / (Discount rate – Perpetual growth rate)
= CN¥1.1 / (8.1% – 1.5%)
Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider China Overseas Land & Investment 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 takes debt into account . In this calculation, we used 8.1%, which is based on a leveraged beta of 1.372. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
While important, the DCF calculation will ideally not be the only piece of analysis you look at for a business. It is not possible to obtain an infallible valuation with a DCF model. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, changes in the company’s cost of equity or in the risk-free rate can have a significant impact on the valuation. For China Overseas Land & Investment, we have compiled three relevant things you should evaluate:
- Financial health: does 688 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors such as leverage and risk.
- Future earnings: How does 688’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!
PS. The Simply Wall St app performs an updated cash flow assessment for each SEHK stock every day. If you want to find the calculation for other stocks, search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.