In this article, we’ll estimate the intrinsic value of DataDot Technology Limited (ASX: DDT) by taking expected future cash flows and discounting them to their present value. To this end, we will take advantage of the Discounted Cash Flow (DCF) model. Patterns like these may seem beyond a layman’s comprehension, but they are fairly easy to follow.

We draw your attention to the fact that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. Anyone who wants to learn a little more about intrinsic value should read the Simply Wall St.

Check out our latest analysis for DataDot technology

Step by step in 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 get cash flow estimates for the next ten years. Since no free cash flow analyst estimate is available, we have extrapolated the previous free cash flow (FCF) from the last reported value of the company. 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 down more in the early years than in subsequent years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and therefore the sum of those future cash flows is then discounted to today’s value. :

10-year free cash flow (FCF) forecast

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = AU $ 2.0 million

The story continues

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 step. 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 (1.9%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 8.4%.

Terminal value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = A $ 500,000 × (1 + 1.9%) ÷ (8.4% – 1.9%) = A $ 7.9 million

Present value of terminal value (PVTV)= TV / (1 + r)^ten= AU $ 7.9m ÷ (1 + 8.4%)^ten= AU $ 3.5 million

The total value is the sum of the cash flows for the next ten years plus the final present value, which gives the total value of equity, which in this case is AU $ 5.5 million. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of AU $ 0.005, the company appears to be around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.

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 or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we view DataDot 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 into account debt. In this calculation, we used 8.4%, which is based on a leveraged beta of 1.375. 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 from globally comparable companies, with a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.

To move on :

While a business valuation is important, ideally it won’t be the only piece of analysis you will look at for a business. The DCF model is not a perfect equity valuation tool. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For DataDot technology, there are three relevant elements that you should consider further:

1. Risks: Note that DataDot technology shows 5 warning signs in our investment analysis , and 2 of them are significant …

2. Other strong companies: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you might not have considered!

3. Other picks from top analysts: Interested in seeing what analysts think? Take a look at our interactive list of analysts’ top stock picks to find out what they think might have a compelling outlook for the future!

PS. Simply Wall St updates its DCF calculation for every Australian stock every day, so if you want to find the intrinsic value of any other stock just search here.

This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is 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 material. Simply Wall St has no position in any of the stocks mentioned.

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