Today we are going to walk through one way to estimate the intrinsic value of Bio-View Ltd (TLV: BIOV) by taking expected future cash flows and discounting them to their present value. On this occasion, we will use the Discounted Cash Flow (DCF) model. Before you think you can’t figure it out, just read on! It’s actually a lot less complex than you might imagine.
We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St analysis template.
Check out our latest analysis for Bio-View
We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. To start, we need to estimate the cash flows for the next ten years. Since no analyst estimates of free cash flow are available to us, we have extrapolated the previous free cash flow (FCF) from the company’s latest reported 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 more in early years than in later years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and so the sum of these future cash flows is then discounted to today’s value:
Estimated free cash flow (FCF) over 10 years
|Leveraged FCF (₪, Millions)||₪3.11m||₪3.00m||₪2.93m||₪2.90m||₪2.89m||₪2.90m||₪2.92m||₪2.94m||₪2.97m||₪3.01m|
|Growth rate estimate Source||Is @ -5.93%||Is @ -3.71%||Is @ -2.15%||Is @ -1.06%||Is @ -0.3%||Is at 0.23%||Is at 0.61%||Is at 0.87%||Is at 1.05%||Is at 1.18%|
|Present value (₪, million) discounted at 6.2%||₪2.9||₪2.7||₪2.4||₪2.3||₪2.1||₪2.0||₪1.9||₪1.8||₪1.7||₪1.7|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = ₪21m
The second stage is also known as the terminal value, it 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 10-year government bond yield of 1.5%. We discount terminal cash flows to present value at a cost of equity of 6.2%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = ₪3.0m × (1 + 1.5%) ÷ (6.2%– 1.5%) = ₪65m
Present value of terminal value (PVTV)= TV / (1 + r)ten= ₪65m÷ ( 1 + 6.2%)ten= ₪36m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is 57 million euros. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of ₪3.4, the company appears to be about fair value at a 17% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play around 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 complete picture of a company’s potential performance. Since we view Bio-View 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 factors in debt. In this calculation, we used 6.2%, which is based on a leveraged beta of 0.949. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Let’s move on :
Valuation is only one side of the coin in terms of crafting your investment thesis, and it shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. If a company grows at a different pace, or if its cost of equity or risk-free rate changes sharply, output may be very different. For Bio-View, we have put together three relevant factors that you should consider in more detail:
- Risks: Take for example the ubiquitous specter of investment risk. We have identified 2 warning signs with Bio-View, and understanding them should be part of your investment process.
- 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 strong trading fundamentals to see if there are any other companies you may not have considered!
- Other top analyst picks: Interested to see what the analysts think? Take a look at our interactive list of analysts’ top stock picks to find out what they think could have attractive future prospects!
PS. The Simply Wall St app performs a discounted cash flow valuation for every stock on the TASE every day. If you want to find the calculation for other stocks, 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 only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.