Is Information Services Group, Inc. (NASDAQ: III) worth US $ 5.8 based on intrinsic value?
Does the Information Services Group, Inc. (NASDAQ: III) stock price for May reflect what it is really worth? Today, we’re going to estimate the intrinsic value of the stock by taking the company’s expected future cash flows and discounting them to present value. We will therefore take advantage of the Discounted Cash Flow (DCF) model. It may sound complicated, but it’s actually quite simple!
Businesses can be valued in many ways, so we would like to stress 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.
Check out our latest analysis for Information Services Group
Crunch the numbers
We use the 2-step growth model, which simply means that we take into account two stages of business growth. During the initial period, the business can have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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 published 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.
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 the present value:
10-year Free Cash Flow (FCF) forecast
|Levered FCF ($, million)||$ 15.6 million||$ 18.2 million||$ 16.1 million||$ 14.9 million||$ 14.2 million||USD 13.8 million||$ 13.7 million||$ 13.6 million||$ 13.7 million||USD 13.8 million|
|Source of estimated growth rate||Analyst x2||Analyst x2||Is at -11.44%||Is at -7.41%||Is at -4.59%||Is at -2.62%||Is at -1.23%||Is at -0.27%||Is 0.41%||Is 0.88%|
|Present value ($, millions) discounted at 7.8%||$ 14.5||$ 15.6||$ 12.8||US $ 11.0||$ 9.8||US $ 8.8||US $ 8.1||7.5 USD||$ 7.0||$ 6.5|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = 101 million USD
The second stage is also known as terminal value, it is the cash flow of the business after the first stage. 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 2.0%. We discount the terminal cash flows to their present value at a cost of equity of 7.8%.
Terminal value (TV)= FCF2030 × (1 + g) ÷ (r – g) = $ 14 million × (1 + 2.0%) ÷ (7.8% – 2.0%) = $ 242 million
Present value of terminal value (PVTV)= TV / (1 + r)ten= 242 million USD ÷ (1 + 7.8%)ten= 114 million USD
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is US $ 215 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 $ 5.8, the company appears reasonably expensive at the time of writing. Remember though, this is only a rough estimate, and like any complex formula – garbage in, garbage out.
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 Information Services Group 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 7.8%, which is based on a leveraged beta of 1.234. 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.
While important, the DCF calculation is just one of the many factors you need to assess for a business. The DCF model is not a perfect inventory valuation tool. Preferably, you apply different cases and assumptions and see how they would impact the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. What is the reason why the stock price exceeds intrinsic value? For Information Services Group, we’ve compiled three important things that you should take a closer look at:
- Risks: Every company has them, and we have spotted 4 warning signs for the information services group you should know.
- Future income: How does III’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.
- 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. The Simply Wall St app performs a daily discounted cash flow assessment for each NASDAQGM share. If you want to find the calculation for other actions, just search here.
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This Simply Wall St article is general in nature. It does not constitute 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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