Does the June price of ALD SA (EPA:ALD) share reflect what it is really worth? Today we are going to estimate the intrinsic value of the stock by estimating the future cash flows of the company and discounting them to their present value. Our analysis 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.
Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St Analysis Template.
See our latest analysis for ALD
We have to calculate the value of ALD slightly differently than other stocks because it is a transportation company. In this approach, dividends per share (DPS) are used, because free cash flow is difficult to estimate and often not reported by analysts. This often underestimates the value of a stock, but it can still be a good comparison against competitors. The “Gordon Growth Model” is used, which simply assumes that dividend payments will continue to increase at a sustainable rate of growth forever. For a number of reasons, a very conservative growth rate is used that cannot exceed that of a company’s Gross Domestic Product (GDP). In this case, we used the 5-year average of the 10-year government bond yield (0.3%). The expected dividend per share is then discounted to its present value at a cost of equity of 5.6%. Compared to the current share price of €12.1, the company looks quite undervalued at a 38% discount to the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in a different galaxy. Keep that in mind.
Value per share = Expected dividend per share / (Discount rate – Perpetual growth rate)
= €1.0 / (5.6% – 0.3%)
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 ALD 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 5.6%, which is based on a leveraged beta of 1.121. 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.
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. DCF models are not the be-all and end-all of investment valuation. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or 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. Why is intrinsic value higher than the current stock price? For ALD, we’ve compiled three additional things you should consider:
- Risks: You should be aware of the 3 warning signs for ALD (2 make us uncomfortable!) that we discovered before considering an investment in the company.
- Future earnings: How does ALD’s growth rate compare to its peers and the wider market? Dive deeper into the analyst consensus figure for the coming years 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 strong trading fundamentals to see if there are any other companies you may not have considered!
PS. The Simply Wall St app performs an updated cash flow assessment for each ENXTPA stock every 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.