Today we are going to review one way to estimate the intrinsic value of ASSA ABLOY AB (publ) (STO: ASSA B) by taking expected future cash flows and discounting them to today’s value. hui. To this end, we will take advantage of 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 businesses can be assessed, so we would like to point out that a DCF is not perfect for all situations. Anyone who wants to learn a little more about intrinsic value should read the Simply Wall St.
See our latest review for ASSA ABLOY
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”. In the first step, we need to estimate the cash flow of the business over 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.
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
|Leverage FCF (SEK, Millions)||kr12.2b||kr13.2b||kr13.4b||kr13.6b||kr13.7b||kr13.8b||kr13.9b||kr14.0b||kr14.1b||kr14.1b|
|Source of estimated growth rate||Analyst x7||Analyst x7||East @ 1.66%||Est @ 1.26%||Est @ 0.98%||East @ 0.79%||Is @ 0.65%||Is @ 0.55%||East @ 0.49%||Is @ 0.44%|
|Present value (SEK, million) discounted at 5.9%||kr11.5k||11.8k kr||kr11.3k||kr10.8k||kr10.3k||9.8k kr||9.3k kr||8.9,000 kr||8.4k kr||8.0 kr|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 100b kr
We now need to calculate the Terminal Value, which takes into account all future cash flows after this ten year period. 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 0.3%. We discount the terminal cash flows to their present value at a cost of equity of 5.9%.
Terminal value (TV)= FCF2031 Ã (1 + g) Ã· (r – g) = kr14b Ã (1 + 0.3%) Ã· (5.9% – 0.3%) = kr255b
Present value of terminal value (PVTV)= TV / (1 + r)ten= kr255b Ã· (1 + 5.9%)ten= kr144b
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 kr244b. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of SEK 263, the company appears to be around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. 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 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 ASSA ABLOY 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 into account debt. In this calculation, we used 5.9%, which is based on a leveraged beta of 1.177. 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.
To move on :
While valuing a business is important, it’s just one of the many factors you need to assess for a business. DCF models are not the alpha and omega of investment valuation. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. 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 ASSA ABLOY, we’ve compiled three fundamental factors you should consider:
- Risks: For example, we discovered 2 warning signs for ASSA ABLOY which you should know before investing here.
- Management: Have insiders increased their stocks to take advantage of market sentiment about ASSA B’s future prospects? Check out our management and board analysis with information on CEO compensation and governance factors.
- 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!
PS. Simply Wall St updates its DCF calculation for every Swedish stock every day, so if you want to find the intrinsic value of any other stock just 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 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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