A look at the fair value of Kuaishou technology (HKG: 1024)
In this article, we will estimate the intrinsic value of Kuaishou Technology (HKG:1024) by taking expected future cash flows and discounting them to the present value. We will use the Discounted Cash Flow (DCF) model for this purpose. Before you think you can’t figure it out, just read on! It’s actually a lot less complex than you might imagine.
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 Kuaishou Technology
The calculation
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. 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
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Leveraged FCF (CN¥, Million) | -CN¥3.77b | CN¥4.21b | CN¥6.82b | CN¥9.80b | CN¥12.8b | CN¥15.7b | CN¥18.2b | CN¥20.3b | CN¥22.1b | CN¥23.5b |
Growth rate estimate Source | Analyst x9 | Analyst x8 | Is at 61.85% | Is at 43.76% | Is at 31.09% | East @ 22.23% | Is at 16.03% | Is at 11.68% | Is at 8.64% | Is at 6.52% |
Present value (CN¥, million) discounted at 6.9% | -CN¥3.5k | CN¥3.7k | CN¥5.6k | CN¥7.5k | CN¥9.2k | CN¥10.5k | CN¥11.4k | CN¥11.9k | CN¥12.1k | CN¥12.1k |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = CN¥80b
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 (1.6%) 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 6.9%.
Terminal value (TV)= FCF_{2032} × (1 + g) ÷ (r – g) = CN¥24b × (1 + 1.6%) ÷ (6.9%–1.6%) = CN¥446b
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= CN¥446b÷ ( 1 + 6.9%)^{ten}= CN¥228b
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 309 billion Canadian yen. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of HK$70.8, the company appears to be about fair value at a 14% 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 hypotheses
We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. 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, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Kuaishou Technology 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 6.9%, which is based on a leveraged beta of 1.086. 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:
Valuation is only one side of the coin in terms of building your investment thesis, and it’s just one of many factors you need to assess for a company. It is not possible to obtain an infallible valuation with a DCF model. 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 Kuaishou Technology, we have compiled three important things you should dig into:
- Risks: For example, we discovered 1 warning sign for Kuaishou Technology which you should be aware of before investing here.
- Future earnings: How does the growth rate of 1024 compare to its peers and the market in general? 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 Hong Kong 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.
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