Does the Your Family Entertainment AG (FRA: RTV) share price for May reflect what it is really worth? Today we will estimate the intrinsic value of the security by taking expected future cash flows and discounting them to their present value. Our analysis will use the Discounted Cash Flow (DCF) model. There really isn’t much to do, although it might seem quite complex.

We generally believe that the value of a business is the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.

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We are going to use a two-step DCF model which, as the name suggests, takes into account two stages of growth. 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 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

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = 4.0 M €

Now we need to calculate the terminal value, which takes into account all future cash flows after that ten year period. 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 0.01%. We discount the terminal cash flows to their present value at a cost of equity of 6.0%.

Terminal value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = € 982k × (1 + 0.01%) ÷ (6.0% – 0.01%) = € 16m

Present value of terminal value (PVTV)= TV / (1 + r)^ten= € 16m ÷ (1 + 6.0%)^ten= 9.2 M €

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which translates into the Total Equity Value which in this case is € 13m. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of € 1.2, the company appears on the fair value with a discount of 4.7% compared to the current share price. 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. You don’t have to agree with these entries, I recommend that you redo the math yourself and play around with it. 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. Because we view Your Family Entertainment 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 6.0%, which is based on a leveraged beta of 1.261. 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.

To move on:

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 inventory valuation tool. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. For your family entertainment, there are three basic things you should explore:

1. Risks: Every company has them, and we have spotted 3 warning signs for your family entertainment you should know.
2. Future income: How does RTV’s growth rate compare to its peers and to the market in general? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth forecast chart.
3. Other strong companies: Low debt, high returns on equity, and good past performance are essential to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every German 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 is not 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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