A look at the fair value of Matrix IT Ltd. (TLV: MTRX)

How far away is Matrix IT Ltd. (TLV: MTRX) of its intrinsic value? Using the most recent financial data, we’ll examine whether the stock price is fair by taking expected future cash flows and discounting them to today’s value. One way to do this is to use the Discounted Cash Flow (DCF) model. Patterns like these may seem beyond a layman’s comprehension, but they are fairly easy to follow.

There are many ways that businesses can be assessed, so we would like to stress that a DCF is not perfect for all situations. Anyone interested in knowing a little more about intrinsic value should read the Simply Wall St analysis model.

See our latest analysis for Matrix IT

Step by step in the calculation

We are going to use a two-step 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 “steady growth”. To begin with, we need to get cash flow estimates for the next ten years. Since no free cash flow analyst estimate is available, we have extrapolated the previous free cash flow (FCF) from the last reported value of the company. 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 down more in the early years than in subsequent years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:

10-year Free Cash Flow (FCF) estimate

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = ₪ 2.3b

The second stage is also known as terminal value, this is the cash flow of the business after the first stage. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.6%. We discount the terminal cash flows to their present value at a cost of equity of 8.0%.

Terminal value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = 378m × (1 + 1.6%) ÷ (8.0% –1.6%) = ₪ 6.0b

Present value of terminal value (PVTV)= TV / (1 + r)^ten= ₪ 6.0b ÷ (1 + 8.0%)^ten= 2.8b

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is ₪ 5.1b. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of 85.7, the company appears to be 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 another galaxy. Keep this in mind.

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. If you don’t agree with these results, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we view Matrix IT 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 8.0%, which is based on a leveraged beta of 1.179. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Looking forward:

While important, calculating DCF shouldn’t be the only metric you look at when looking for a business. The DCF model is not a perfect equity valuation tool. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. For Matrix IT, we have compiled three relevant aspects that you should explore:

1. Risks: For example, we discovered 2 warning signs for Matrix IT which you should know before investing here.
2. Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!
3. Other environmentally friendly companies: Are you concerned about the environment and think that consumers will buy more and more environmentally friendly products? Browse our interactive list of companies thinking about a greener future to discover stocks you might not have thought of!

PS. The Simply Wall St app performs a daily discounted cash flow assessment for each TASE share. If you want to find the calculation for other actions, do a search here.

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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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