A look at the fair value of Net Insight AB (publ) (STO: NETI B)
Today, we are going to take a simple overview of a valuation method used to estimate the attractiveness of Net Insight AB (publ) (STO: NETI B) as an investment opportunity by projecting its flows future cash flows and then discounting them to present value. This will be done using the Discounted Cash Flow (DCF) model. Don’t be put off by the lingo, the math is actually pretty straightforward.
There are many ways that businesses can be valued, so we would like to stress that a DCF is not perfect for all situations. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.
Check out our latest analysis for Net Insight
The calculation
We use the 2-step growth model, which simply means that we take into account two stages of business growth. During the initial period, the business can have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we need to estimate the next ten years of cash flow. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or the last reported value. We assume that companies with decreasing free cash flow will slow their withdrawal rate, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect that growth tends to slow down more in the early years than in the later years.
Typically, we assume that a dollar today is worth more than a dollar in the future, and so the sum of these future cash flows is then discounted to present value:
10-year Free Cash Flow (FCF) forecast
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Leverage FCF (SEK, millions) | 129.0 million kr | 27.0 million kr | 33.0 million kr | 34.5 million kr | 35.7 million kr | 36.6 million kr | 37.2 million kr | 37.7 million kr | 38.1 million kr | 38.4 million kr |
Source of estimated growth rate | Analyst x1 | Analyst x1 | Analyst x1 | Is 4.64% | Is 3.35% | Is 2.44% | Is 1.81% | Is 1.37% | Is 1.05% | Is 0.84% |
Present value (SEK, million) discounted at 4.7% | 123 kr | 24.6 kr | 28.7 kr | 28.7 kr | 28.3 kr | 27.7 kr | 26.9 kr | 26.1 kr | 25.2 kr | 24.2 kr |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = kr363m
Now we need to calculate the terminal value, which takes into account all future cash flows after that ten year period. For a number of reasons, a very conservative growth rate is used that 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 4.7%.
Terminal value (TV)= FCF_{2030} × (1 + g) ÷ (r – g) = kr38m × (1 + 0.3%) ÷ (4.7% – 0.3%) = kr878m
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= 878 m kr ÷ (1 + 4.7%)^{ten}= kr553m
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is 916 million kr. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of 2.5kr, the company is around fair value at the time of writing. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
Important assumptions
We draw your attention to the fact that the most important data for a discounted cash flow is the discount rate and, of course, the actual cash flow. If you don’t agree with these results, try the calculation yourself and play with the 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 Net Insight 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 into account debt. In this calculation, we used 4.7%, which is based on a leveraged beta of 0.931. 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.
Looking forward:
While valuing a business is important, it is only one of the many factors you need to assess for a business. DCF models are not the alpha and omega of investment valuation. Preferably, you would apply different cases and assumptions and see how they would impact the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For Net Insight, we’ve put together three basic things you should research further:
- Financial health: Does NETI B have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future income: How does NETI B’s growth rate compare to its peers and to the overall market? Dig deeper into the analyst consensus count for years to come 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 inventory to get a feel for what you might be missing!
PS. Simply Wall St updates its DCF calculation for every Swedish stock every day, 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. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals or your financial situation. We aim to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative information. Simply Wall St has no position in any of the stocks mentioned.
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