Today we’re going to go over one way to estimate the intrinsic value of Doctor Care Anywhere Group PLC (ASX: DOC) by projecting its future cash flows and then discounting them to present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There really isn’t much to it, although it might seem quite complex.
We generally think of a business’s value as the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something that interests you.
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Step by step in the calculation
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. In the first step, we have to estimate the cash flow of the business over the next ten years. 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 stated 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 down more in the early years than in subsequent years.
In general, we assume that a dollar today is worth more than a dollar in the future, 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) estimate
|Leverage FCF (£, Million)||-UK £ 8.90m||United Kingdom £ 2.20 million||United Kingdom £ 3.39 million||United Kingdom £ 4.70 million||UK £ 6.00m||United Kingdom £ 7.19 million||United Kingdom £ 8.23 million||United Kingdom £ 9.10 million||United Kingdom £ 9.84 million||United Kingdom £ 10.4million|
|Source of growth rate estimate||Analyst x1||Analyst x1||East @ 54.28%||East @ 38.55%||Is 27.55%||Est @ 19.84%||Est @ 14.45%||Est @ 10.67%||Est @ 8.03%||Est @ 6.18%|
|Present value (£, million) discounted at 6.0%||-UK £ 8.4||United Kingdom £ 2.0||United Kingdom £ 2.9||United Kingdom £ 3.7||United Kingdom £ 4.5||United Kingdom5,1 €||£ 5.5||United Kingdom £ 5.7||United Kingdom £ 5.8||United Kingdom £ 5.8|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 32 million pounds sterling in the United Kingdom
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 1.9%. We discount the terminal cash flows to their present value at a cost of equity of 6.0%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = UK £ 10m × (1 + 1.9%) ÷ (6.0% – 1.9%) = UK £ 258m
Present value of terminal value (PVTV)= TV / (1 + r)ten= UK £ 258m ÷ (1 + 6.0%)ten= £ 144 million in the UK
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is £ 176million. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of AU $ 0.6, the company appears to be quite undervalued with a 37% discount 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 cash flow. If you don’t agree with these results, try the calculation yourself and play with the 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 full picture of a company’s potential performance. Since we consider Doctor Care Anywhere 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 the debt. In this calculation, we used 6.0%, which is based on a leveraged beta of 0.843. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry 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 important, calculating DCF is just one of the many factors you need to assess for a business. It is not possible to achieve a rock-solid 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, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. Why is intrinsic value greater than the current share price? For the Doctor Care Anywhere group, we’ve put together three important areas you should research further:
- Risks: You should be aware of the 2 warning signs for the Doctor Care Anywhere group we found out before considering an investment in the business.
- Future benefits: How does DOC’s growth rate compare to its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
- 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!
PS. Simply Wall St updates its DCF calculation for every Australian stock every day, so if you want to find the intrinsic value of any other stock just search here.
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 shares 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 material. Simply Wall St has no position in any of the stocks mentioned.
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