Estimated fair value of Electrameccanica Vehicles Corp. (NASDAQ: SOLO)
What is the distance between Electrameccanica Vehicles Corp. (NASDAQ:SOLO) and its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by taking the company’s projected future cash flows and discounting them to the present value. This will be done using the discounted cash flow (DCF) model. Patterns like these may seem beyond a layman’s comprehension, but they’re pretty easy to follow.
We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.
Step by step in the calculation
We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. To start, we need to estimate the cash flows for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported 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 more in early years than in later 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) Forecast
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Leveraged FCF ($, millions) | -$30.7 million | -$13.6 million | $5.30 million | $8.24 million | $11.5 million | $14.7 million | $17.7 million | $20.3 million | $22.5 million | $24.4 million |
Growth rate estimate Source | Analyst x1 | Analyst x1 | Analyst x1 | Is at 55.4% | Is at 39.36% | East @ 28.13% | East @ 20.28% | Is at 14.78% | Is at 10.92% | Is at 8.23% |
Present value (in millions of dollars) discounted at 8.7% | -$28.2 | -$11.5 | $4.1 | $5.9 | $7.6 | $8.9 | $9.9 | $10.4 | $10.7 | $10.6 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $28 million
We now need to calculate the terminal value, which represents all future cash flows after this 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 10-year government bond yield of 1.9%. We discount terminal cash flows to present value at a cost of equity of 8.7%.
Terminal value (TV)= FCF_{2032} × (1 + g) ÷ (r – g) = $24 million × (1 + 1.9%) ÷ (8.7%–1.9%) = $369 million
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= $369 million ÷ (1 + 8.7%)^{ten}= $161 million
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is $189 million. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of $1.5, the company appears to be about fair value at an 8.2% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
The hypotheses
Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. If you disagree with these results, try the math yourself and play around with the assumptions. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Electrameccanica Vehicles 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 8.7%, which is based on a leveraged beta of 1.588. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Let’s move on :
Valuation is only one side of the coin in terms of building your investment thesis, and it’s just one of many factors you need to assess for a company. It is not possible to obtain an infallible 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, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. For Electrameccanica vehicles, we have put together three additional factors that you should consider in more detail:
- Risks: Take for example the ubiquitous specter of investment risk. We have identified 3 warning signs with Electrameccanica Vehicles, and understanding them should be part of your investment process.
- Future earnings: How does SOLO’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years 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 actions to get an idea of what you might be missing!
PS. Simply Wall St updates its DCF calculation for every US stock daily, so if you want to find the intrinsic value of any other stock, do a search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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