Does the June price of SBM Offshore NV (AMS:SBMO) stock reflect what it is really worth? Today we are going to estimate the intrinsic value of the stock by taking the expected future cash flows of the business and discounting them to today’s value. One way to do this is to use the discounted cash flow (DCF) model. Believe it or not, it’s not too hard to follow, as you’ll see in our example!
Remember though that there are many ways to estimate the value of a business and a DCF is just one method. If you want to know more about discounted cash flows, the rationale for this calculation can be read in detail in the Simply Wall St Analysis Template.
Check out our latest analysis for SBM Offshore
Is SBM Offshore correctly valued?
We have to calculate the value of SBM Offshore a little differently than other stocks because it is an energy services company. In this approach, dividends per share (DPS) are used, because free cash flow is difficult to estimate and often not reported by analysts. Unless a company pays the majority of its FCF as a dividend, this method will generally underestimate the value of the stock. We use Gordon’s growth model, which assumes that the dividend will grow in perpetuity at a rate that can be sustained. 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 (0.09%). The expected dividend per share is then discounted to its present value at a cost of equity of 8.6%. Compared to the current share price of €13.3, the company appears to be approximately fair value at a 1.6% discount to the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep that in mind.
Value per share = Expected dividend per share / (Discount rate – Perpetual growth rate)
= US$1.2 / (8.6% – 0.09%)
Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. 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 complete picture of a company’s potential performance. Since we consider SBM Offshore 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 8.6%, which is based on a leveraged beta of 1.997. 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.
Let’s move on :
While important, calculating DCF shouldn’t be the only metric to consider when researching a business. The DCF model is not a perfect stock valuation tool. 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. For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. For SBM Offshore, we’ve compiled three more things you should explore:
- Risks: For example, we spotted 3 warning signs for SBM Offshore you need to be aware of, and 1 of them should not be ignored.
- Future earnings: How does SBMO’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 a daily updated cash flow valuation for each ENXTAM stock. 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.