Calculating the intrinsic value of HireQuest, Inc. (NASDAQ: HQI)
Today we’re going to review a valuation method used to estimate the attractiveness of HireQuest, Inc. (NASDAQ: HQI) as an investment opportunity by taking expected future cash flows and discounting them. at their current value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but it’s actually quite simple!
There are many ways businesses can be assessed, so we would like to point out 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.
Crunch the numbers
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. In the first step, we need to estimate the cash flow of the business over 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.
Generally, 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 today’s value:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF ($, Millions)||$ 11.3 million||US $ 11.2 million||US $ 11.2 million||$ 11.3 million||US $ 11.4 million||US $ 11.5 million||US $ 11.7 million||US $ 11.9 million||US $ 12.1 million||US $ 12.3 million|
|Source of estimated growth rate||East @ -2.2%||East @ -0.94%||East @ -0.06%||Is @ 0.55%||Est @ 0.98%||Est @ 1.29%||Is 1.5%||Is @ 1.65%||Is @ 1.75%||East @ 1.82%|
|Present value (in millions of dollars) discounted at 6.3%||$ 10.7||$ 9.9||$ 9.4||US $ 8.9||US $ 8.4||US $ 8.0||$ 7.7||$ 7.3||US $ 7.0||$ 6.7|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 83 million
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 (2.0%) 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 6.3%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US $ 12 million × (1 + 2.0%) ÷ (6.3% – 2.0%) = US $ 295 million
Present value of terminal value (PVTV)= TV / (1 + r)ten= US $ 295 million ÷ (1 + 6.3%)ten= US $ 161 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 $ 244 million. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of US $ 19.8, the company appears to be around fair value at the time of writing. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
NasdaqCM: HQI Discounted Cash Flows September 17, 2021
Now, the most important inputs to a discounted cash flow are 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 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 HireQuest 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 6.3%, which is based on a leveraged beta of 0.903. 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 important, calculating DCF shouldn’t be the only metric you look at when looking for a business. It is not possible to achieve a rock-solid valuation with a DCF model. 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 HireQuest, we’ve put together three relevant aspects that you should explore:
- Risks: For example, we have identified 1 warning sign for HireQuest that you need to be aware of.
- 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!
- Other environmentally friendly companies: Are you concerned about the environment and think that consumers will buy more and more environmentally friendly products? Browse our interactive list of companies thinking about a greener future to discover stocks you may not have thought of!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each NASDAQCM share. If you want to find the calculation for other actions, just search here.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. 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 documents. Simply Wall St has no position in the mentioned stocks.
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.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.