Today we are going to review one way to estimate the intrinsic value of Mutual-Tek Industries Co., Ltd. (GTSM: 6407) by taking expected future cash flows and discounting them to their present value. To this end, we will take advantage of the Discounted Cash Flow (DCF) model. There really isn’t much to do, although it might seem quite complex.
We would like to point out that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. If you want to know more about discounted cash flows, the rationale for this calculation can be read in detail in the Simply Wall St analysis model.
Check out our latest review for Mutual-Tek Industries
As Mutual-Tek Industries operates in the electronics industry, we have to calculate intrinsic value slightly differently. In this approach, dividends per share (DPS) are used because free cash flow is difficult to estimate and often goes unreported by analysts. This often underestimates the value of a stock, but it can still be good in comparison to the competition. We use the Gordon Growth Model, which assumes that the dividend will grow in perpetuity at a rate that can be sustained. For a number of reasons, a very conservative growth rate is used that cannot exceed that of a company’s gross domestic product (GDP). In this case, we used the 5-year average of the 10-year government bond yield (0.8%). The expected dividend per share is then discounted to present value at a cost of equity of 9.1%. From the current share price of NT $ 13.5, the company appears at fair value at a discount of 7.5% from the current share price. 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.
Value per share = expected dividend per share / (discount rate – perpetual growth rate)
= NT $ 1.2 / (9.1% – 0.8%)
= NT $ 14.5
The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. Part of investing is making 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 complete picture of a company’s potential performance. Since we view Mutual-Tek Industries 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 9.1%, which is based on a leveraged beta of 1.349. 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 of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
While a business valuation is important, it shouldn’t be the only metric you look at when researching a business. DCF models are not the alpha and omega of investment valuation. 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 Mutual-Tek Industries, we’ve put together three relevant things that you should take a closer look at:
- Risks: For example, we discovered 5 warning signs for Mutual-Tek Industries which you should be aware of before investing here.
- Other strong companies: Low debt, high returns on equity, and good past performance are essential 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 top analyst picks: Interested in seeing what analysts think? Take a look at our interactive list of analysts’ top stock picks to find out what they think might have a compelling outlook for the future!
PS. Simply Wall St updates its DCF calculation for every Taiwanese stock every day, so if you want to find the intrinsic value of any other stock just search here.
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