Today we’re going to go over one way to estimate the intrinsic value of Alma Media Oyj (HEL: ALMA) by projecting its future cash flows and then discounting them to today’s value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Patterns like these may seem beyond a layman’s comprehension, but they are fairly easy to follow.
We generally think of a business’s value as the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.
Discover our latest analysis for Alma Media Oyj
Crunch the numbers
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. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated 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 down more in the early years than in subsequent years.
In general, we assume that a dollar today is worth more than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today’s dollars:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF (€, Millions)||€ 61.7m||€ 64.9m||€ 62.2m||€ 65.4m||€ 66.0m||€ 66.5m||€ 66.9m||€ 67.2m||67.5 million euros||€ 67.7m|
|Source of estimated growth rate||Analyst x3||Analyst x3||Analyst x1||Analyst x1||Est @ 0.98%||East @ 0.74%||Is @ 0.58%||Is @ 0.46%||East @ 0.38%||Is @ 0.32%|
|Present value (€, Millions) discounted at 4.9%||€ 58.8||€ 59.0||€ 53.9||€ 54.0||€ 52.0||€ 50.0||€ 47.9||€ 45.9||€ 43.9||€ 42.0|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 507 M €
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 (0.2%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 4.9%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = € 68m × (1 + 0.2%) ÷ (4.9% – 0.2%) = € 1.4bn
Present value of terminal value (PVTV)= TV / (1 + r)ten= € 1.4bn ÷ (1 + 4.9%)ten= 895 M €
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is € 1.4 billion. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of € 11.6, the company appears to be fairly good value with a 32% discount 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 view Alma Media Oyj as a potential shareholder, 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 4.9%, which is based on a leveraged beta of 0.998. 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.
Valuation is only one side of the coin in terms of building your investment thesis, and it’s just one of the many factors you need to evaluate 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?” For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. Can we understand why the company trades at a discount to its intrinsic value? For Alma Media Oyj, you need to explore three other aspects:
- Risks: To do this, you need to know the 2 warning signs we spotted with Alma Media Oyj.
- Future benefits: How does ALMA’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth expectations chart.
- 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 might not have considered!
PS. Simply Wall St updates its DCF calculation for every Finnish stock every day, so if you want to find the intrinsic value of any other stock 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 material. Simply Wall St has no position in the mentioned stocks.
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