Garo Aktiebolag (publ) (STO:GARO) shares could be 20% above their estimated intrinsic value

How far is Garo Aktiebolag (publ) (STO:GARO) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by taking expected future cash flows and discounting them to their present value. This will be done using the discounted cash flow (DCF) model. There really isn’t much to do, although it may seem quite complex.

Remember though that there are many ways to estimate the value of a business and a DCF is just one method. 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.

Discover our latest analysis for Garo Aktiebolag

The method

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. In the first step, we need to estimate the company’s cash flow over 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 need to discount the sum of these future cash flows to arrive at an estimate of present value:

Estimated free cash flow (FCF) over 10 years

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = kr1.7b

We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. For a number of reasons, a very conservative growth rate is used which 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 (0.3%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 5.3%.

Terminal value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = kr300m × (1 + 0.3%) ÷ (5.3%– 0.3%) = kr6.0b

Present value of terminal value (PVTV)= TV / (1 + r)^ten= kr6.0b÷ ( 1 + 5.3%)^ten= kr3.6b

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is 5.3 billion kr. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of 127 kr, the company appears slightly overvalued at the time of writing. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.

Important assumptions

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 consider Garo Aktiebolag 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 5.3%, which is based on a leveraged beta of 1.173. 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.

Next steps:

While important, the DCF calculation will ideally not be the only piece of analysis you look at for a business. 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. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. What is the reason why the stock price exceeds the intrinsic value? For Garo Aktiebolag, we’ve put together three more things you should consider in more detail:

1. Risks: Every business has them, and we’ve spotted 1 warning sign for Garo Aktiebolag you should know.
2. Management:Did insiders increase their shares to take advantage of market sentiment about GARO’s future prospects? View our management and board analysis with insights into CEO compensation and governance factors.
3. 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. The Simply Wall St app performs an updated cash flow valuation for every stock on OM 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.