Today we are going to take a simple walkthrough of a valuation method used to estimate the attractiveness of Italmobiliare SpA (BIT:ITM) as an investment opportunity by taking the projected future cash flows of the company and discounting them to the current value. One way to do this is to use the discounted cash flow (DCF) model. Before you think you can’t figure it out, just read on! It’s actually a lot less complex than you might imagine.
We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.
Discover our latest analysis for Italmobiliare
We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. To start, we need to estimate the cash flows for the next ten years. Since no analyst estimate of free cash flow is available, we have extrapolated the previous free cash flow (FCF) from the company’s latest reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.
Generally, we assume that a dollar today is worth more 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) Forecast
|Leveraged FCF (€, Millions)||€62.1 million||€65.5 million||€68.3 million||€70.8 million||€72.9 million||€74.8 million||€76.6m||€78.3 million||€79.9 million||€81.4 million|
|Growth rate estimate Source||Is at 7.03%||Is at 5.44%||Is at 4.34%||Is at 3.56%||Is at 3.02%||Is at 2.64%||Is at 2.37%||Is at 2.18%||Is at 2.05%||Is 1.96%|
|Present value (€, millions) discounted at 7.7%||57.7 €||56.5 €||54.7 €||52.7 €||50.4 €||€48.0||45.7 €||43.3 €||41.1 €||38.9 €|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = €488 million
The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (1.8%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 7.7%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = €81 million × (1 + 1.8%) ÷ (7.7%–1.8%) = €1.4 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= €1.4 billion÷ ( 1 + 7.7%)ten= €668 million
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is 1.2 billion euros. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of €30.5, 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.
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play around with them. 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 Italmobiliare 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 7.7%, which is based on a leveraged beta of 0.951. 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.
Although the valuation of a business is important, it will ideally not be the only piece of analysis you will 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 the risk-free rate can have a significant impact on the valuation. For Italmobiliare, there are three essential aspects that you must explore:
- Risks: For example, we spotted 2 warning signs for Italmobiliare you should know, and one of them makes us a little uneasy.
- Future earnings: How does ITM’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 high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
PS. The Simply Wall St app performs a daily updated cash flow valuation for each stock on the BIT. If you want to find the calculation for other stocks, search here.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
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.