Does the June Intercos SpA (BIT:ICOS) stock price reflect what it is really worth? Today we are going to estimate the intrinsic value of the stock by taking the expected future cash flows and discounting them to their present value. One way to do this is to use the discounted cash flow (DCF) model. There really isn’t much to do, although it may seem quite complex.
Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. For those who are passionate about stock analysis, the Simply Wall St analysis template here may interest you.
See our latest analysis for Intercos
crush numbers
We use what is called a 2-stage model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. To begin with, we need to obtain cash flow estimates for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or 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, so we discount the value of these future cash flows to their estimated value in today’s dollars:
Estimated free cash flow (FCF) over 10 years
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leveraged FCF (€, Millions) | €53.0m | €69.0m | €81.0 million | €89.7 million | €97.0 million | €102.9 million | €107.9 million | €112.1 million | €115.7 million | €118.9 million |
Growth rate estimate Source | Analyst x1 | Analyst x1 | Analyst x1 | Is at 10.79% | Is at 8.06% | Is at 6.15% | Is at 4.81% | Is at 3.87% | Is at 3.22% | Is at 2.76% |
Present value (€, millions) discounted at 8.9% | 48.7 € | 58.2 € | 62.7 € | 63.8 € | 63.3 € | 61.7 € | 59.3 € | 56.6 € | 53.6 € | 50.6 € |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = €578 million
After calculating the present value of future cash flows over the initial 10-year period, we need to calculate the terminal value, which takes into account all future cash flows beyond 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 1.7%. We discount terminal cash flows to present value at a cost of equity of 8.9%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = €119m × (1 + 1.7%) ÷ (8.9%– 1.7%) = €1.7bn
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= €1.7 billion÷ ( 1 + 8.9%)^{ten}= €712 million
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is 1.3 billion euros. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of €13.5, the company appears around fair value at the time of writing. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
The hypotheses
Now, 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 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 consider Intercos 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 8.9%, which is based on a leveraged beta of 1.125. 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.
Look forward:
While a business valuation is important, it shouldn’t be the only metric to consider when researching a business. DCF models are not the be-all and end-all 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 company grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output may be very different. For Intercos, there are three essential factors that you should examine in more detail:
- Risks: For example, we spotted 2 warning signs for Intercos you should be aware.
- Future earnings: How does ICOS’ growth rate compare to its peers and the wider market? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
PS. Simply Wall St updates its DCF calculation for every Italian stock daily, 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 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.