Does the October share price for Ashiana Housing Limited (NSE: ASHIANA) reflect what it is really worth? Today, we’re going to estimate the intrinsic value of the stock by estimating the company’s future cash flows and discounting them to their present value. To this end, we will take advantage of the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too hard to follow, as you will see in our example!
We draw your attention to the fact that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something of interest to you.
See our latest analysis for Ashiana Housing
Step by step in the calculation
We use the 2-step growth model, which simply means that we take into account two stages of business growth. In the initial period, the business can have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. To begin with, we need to estimate the next ten years of cash flow. 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, and therefore the sum of those future cash flows is then discounted to today’s value. :
10-year free cash flow (FCF) forecast
|Leverage FCF (â¹, Millions)||1.26b||1.39b||1.51b||1.63b||1.76b||1.89b||2.03b||â¹ 2.17b||â¹ 2.33b||â¹ 2.49b|
|Source of estimated growth rate||Est @ 11.04%||East @ 9.75%||Est @ 8.85%||East @ 8.22%||Est @ 7.77%||Est @ 7.46%||Est @ 7.25%||Est @ 7.09%||Is 6.99%||Est @ 6.91%|
|Present value (â¹, millions) discounted at 14%||1.1k||â¹ 1.1k||1.0k||â¹ 963||909||â¹ 856||â¹ 804||â¹ 755||â¹ 708||â¹ 663|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = â¹ 8.8b
The second stage is also known as terminal value, this is the cash flow of the business after the first stage. For a number of reasons, a very conservative growth rate is used that 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 (6.7%) to estimate future growth. Similar to the 10-year âgrowthâ period, we discount future cash flows to their present value, using a cost of equity of 14%.
Terminal value (TV)= FCF2031 Ã (1 + g) Ã· (r – g) = â¹ 2.5b Ã (1 + 6.7%) Ã· (14% – 6.7%) = â¹ 36b
Present value of terminal value (PVTV)= TV / (1 + r)ten= â¹ 36b Ã· (1 + 14%)ten= 9.6b
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 â¹ 18b. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of 177, the company is shown at fair value at a discount of 1.4% from the current share price. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
We draw your attention to the fact that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play with them. 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 full picture of a company’s potential performance. Since we consider Ashiana Housing to be 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 into account debt. In this calculation, we used 14%, which is based on a leveraged beta of 1.187. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average beta from globally comparable companies, with a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.
To move on :
While important, calculating DCF is just one of the many factors you need to assess for a business. It is not possible to achieve a rock-solid valuation with a DCF model. 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 Ashiana Housing, we have compiled three important things you need to assess:
- Risks: Take risks, for example – Ashiana Housing a 1 warning sign we think you should be aware.
- Other strong companies: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you may not have considered!
- 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 may not have thought of!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each NSEI share. If you want to find the calculation for other actions, just search here.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. 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 any of the stocks mentioned.
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