A look at the intrinsic value of Joy Spreader Interactive Technology Co. Ltd (HKG: 6988)
Does the July share price for Joy Spreader Interactive Technology Co. Ltd (HKG: 6988) reflect its true value? Today we’re going to estimate the intrinsic value of the stock by taking expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. There really isn’t much to it, although it might seem quite complex.
Remember, however, that there are many ways to estimate the value of a business, and a DCF is just one method. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.
Check out our latest review for Joy Spreader Interactive Technology
We’re going to use a two-step DCF model, which, as the name suggests, takes into account two growth stages. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “steady growth”. To begin with, we need to get cash flow estimates for the next ten years. 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 stated 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 down more in the early years than in subsequent years.
In general, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF (HK $, Millions)||72.7 million Hong Kong dollars||HK $ 134.4 million||HK $ 186.5 million||HK $ 238.1 million||HK $ 285.2 million||HK $ 325.9 million||HK $ 359.9 million||HK $ 387.9 million||HK $ 410.6 million||HK $ 429.3 million|
|Source of estimated growth rate||Analyst x2||Analyst x2||Est @ 38.82%||Est @ 27.62%||Est @ 19.78%||Is at 14.29%||Est @ 10.45%||Est @ 7.76%||Est @ 5.87%||East @ 4.56%|
|Present value (HK $, Million) discounted at 6.2%||68.4 HK $||119 HK $||156 HK $||187 HK $||211 HK $||227 HK $||236 HK $||239 HK $||238 HK $||235 HK $|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = HK $ 1.9 billion
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. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.5%. We discount the terminal cash flows to their present value at a cost of equity of 6.2%.
Terminal value (TV)= FCF2031 Ã (1 + g) Ã· (r – g) = HK $ 429 million Ã (1 + 1.5%) Ã· (6.2% – 1.5%) = HK $ 9.2 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= HK $ 9.2b Ã· (1 + 6.2%)ten= HK $ 5.0 billion
Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is HK $ 6.9 billion. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of HK $ 3.0, the company appears to be roughly at fair value with a 7.0% discount to the current share price. 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 above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play 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 view Joy Spreader Interactive 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 the debt. In this calculation, we used 6.2%, which is based on a leveraged beta of 0.879. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching 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, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. For Joy Spreader Interactive Technology, there are three fundamental elements that you should take a closer look at:
- Risks: Take risks, for example – Joy Spreader Interactive Technology has 2 warning signs (and 1 that shouldn’t be ignored) we think you should be aware of.
- Future benefits: How does 6988’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
- 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!
PS. Simply Wall St updates its DCF calculation for every Hong Kong stock every day, so if you want to find the intrinsic value of any other stock just search here.
If you are looking to trade a wide range of investments, open an account with the cheapest * platform that professionals trust, Interactive Brokers. Their clients from more than 200 countries and territories trade stocks, options, futures, currencies, bonds and funds around the world from a single integrated account.
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 the mentioned stocks.
*Interactive Brokers Ranked Least Expensive Broker By StockBrokers.com Online Annual Review 2020
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.