Today we’re going to review one way to estimate the intrinsic value of Paramount Communications Limited (NSE: PARACABLES) by taking the company’s future cash flow forecasts and discounting them to today’s value. hui. To this end, we will take advantage of the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too hard to follow, as you will see in our example!
Remember, however, that there are many ways to estimate the value of a business and that a DCF is just one method. If you still have burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
Check out our latest review for Paramount Communications
What is the estimated valuation?
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. 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 (â¹, Millions)||83.7m||â¹ 132.1m||â¹ 188.3 m||248.1m||â¹ 308.3m||366.9m||423.1m||477.0m||â¹ 529.3m||â¹ 580.5m|
|Source of estimated growth rate||East @ 79.73%||Est @ 57.83%||East @ 42.5%||Est @ 31.77%||East @ 24.26%||Est @ 19.01%||East @ 15.33%||Est @ 12.75%||Est @ 10.95%||Est @ 9.69%|
|Present value (â¹, millions) discounted at 17%||71.6||â¹ 96.6||â¹ 118||133||141||143||141||136||129||121|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 1.2b
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. 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 6.7%. We discount the terminal cash flows to their present value at a cost of equity of 17%.
Terminal value (TV)= FCF2031 Ã (1 + g) Ã· (r – g) = â¹ 581m Ã (1 + 6.7%) Ã· (17% – 6.7%) = â¹ 6.1b
Present value of terminal value (PVTV)= TV / (1 + r)ten= â¹ 6.1b Ã· (1 + 17%)ten= â¹ 1.3b
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is â¹ 2.5b. To get the intrinsic value per share, we divide it by the total number of shares outstanding. From the current share price of 11.4, the company is shown at fair value at a discount of 11% from the current share price. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
The above calculation is very dependent on two assumptions. One is the discount rate and the other is the cash flow. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play around 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 full picture of a company’s potential performance. Since we view Paramount Communications 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 17%, which is based on a leveraged beta of 1.637. 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 comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
While a business valuation is important, it shouldn’t be the only metric you look at when researching a business. The DCF model is not a perfect stock assessment tool. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. For Paramount Communications, we’ve put together three important factors you should research further:
- Risks: For example, we have identified 4 warning signs for Paramount Communications (1 should not be ignored) you should be aware of this.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!
- 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 might not have thought of!
PS. Simply Wall St updates its DCF calculation for every Indian stock every day, so if you want to find the intrinsic value of another stock just 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 using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock 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 any of the stocks mentioned.