Estimated fair value of Motor & General Finance Limited (NSE: MOTOGENFIN)
Today we are going to give a simple overview of a valuation method used to estimate the attractiveness of The Motor & General Finance Limited (NSE:MOTOGENFIN) as an investment opportunity by projecting its flows future cash flows, then discounting them to the present value. On this occasion, we will use the Discounted Cash Flow (DCF) model. Patterns like these may seem beyond a layman’s comprehension, but they’re pretty easy to follow.
We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.
Check out our latest analysis for Motor & General Finance
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. In the first step, we need to estimate the company’s cash flow over the next ten years. Since no analyst estimate of free cash flow is available, we have extrapolated the previous free cash flow (FCF) from the company’s latest 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.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:
Estimated free cash flow (FCF) over 10 years
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leveraged FCF (₹, million) | ₹92.0 million | ₹101.8 million | ₹111.5 million | ₹121.2 million | ₹131.0m | ₹141.1 million | ₹151.5 million | ₹162.4m | ₹173.9 million | ₹186.0m |
Growth rate estimate Source | Is at 12.41% | Is at 10.71% | Is at 9.51% | Is at 8.68% | Is at 8.09% | Is at 7.68% | Is at 7.4% | Is at 7.2% | Is at 7.06% | Is at 6.96% |
Present value (₹, million) discounted at 13% | ₹81.2 | ₹79.3 | ₹76.6 | ₹73.4 | ₹70.0 | ₹66.5 | ₹63.0 | ₹59.6 | ₹56.3 | ₹53.1 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) =₹678m
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 6.7%. We discount terminal cash flows to present value at a cost of equity of 13%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = ₹186m × (1 + 6.7%) ÷ (13%–6.7%) = ₹3.0b
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= ₹3.0b÷ ( 1 + 13%)^{ten}=₹854m
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is ₹1.5 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of ₹32.0, the company appears to be roughly fair value at a 19% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
Important assumptions
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the 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 complete picture of a company’s potential performance. Since we consider Motor & General Finance 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 13%, which is based on a leveraged beta of 1.033. 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.
Next steps:
Although the valuation of a business is important, it will ideally not be the only piece of analysis you will look at for a business. 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?” If a company grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output may be very different. For Motor & General Finance, we’ve compiled three relevant things you should consider:
- Risks: Every business has them, and we’ve spotted 3 warning signs for Motor & General Finance (of which 1 does not suit us too much!) that you should know.
- 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!
- Other top analyst picks: Interested to see what the analysts think? Take a look at our interactive list of analysts’ top stock picks to find out what they think could have attractive future prospects!
PS. The Simply Wall St app performs an updated cash flow valuation for each NSEI stock each day. If you want to find the calculation for other stocks, 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.