Is Alpha Financial Markets Consulting plc (LON:AFM) Trading At A 40% Discount?

editorial-team@simplywallst.com (Simply Wall St)
6 min read
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Key Insights

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Alpha Financial Markets Consulting plc (LON:AFM) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Alpha Financial Markets Consulting

The Model

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF (£, Millions)

UK£23.0m

UK£28.6m

UK£31.1m

UK£33.0m

UK£34.5m

UK£35.8m

UK£36.9m

UK£37.9m

UK£38.8m

UK£39.7m

Growth Rate Estimate Source

Analyst x2

Analyst x3

Analyst x3

Est @ 5.96%

Est @ 4.66%

Est @ 3.76%

Est @ 3.12%

Est @ 2.68%

Est @ 2.37%

Est @ 2.15%

Present Value (£, Millions) Discounted @ 6.5%

UK£21.6

UK£25.2

UK£25.8

UK£25.6

UK£25.2

UK£24.5

UK£23.8

UK£22.9

UK£22.0

UK£21.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£238m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.6%. We discount the terminal cash flows to today's value at a cost of equity of 6.5%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = UK£40m× (1 + 1.6%) ÷ (6.5%– 1.6%) = UK£829m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£829m÷ ( 1 + 6.5%)10= UK£441m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£679m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£3.6, the company appears quite good value at a 40% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
dcf

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Alpha Financial Markets Consulting 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 accounts for debt. In this calculation we've used 6.5%, which is based on a levered beta of 0.888. Beta is a measure of a stock's volatility, compared 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.

SWOT Analysis for Alpha Financial Markets Consulting

Strength

  • Debt is not viewed as a risk.

Weakness

  • Earnings declined over the past year.

  • Dividend is low compared to the top 25% of dividend payers in the Professional Services market.

Opportunity

  • Annual earnings are forecast to grow faster than the British market.

  • Trading below our estimate of fair value by more than 20%.

Threat

  • Dividends are not covered by earnings.

  • Revenue is forecast to grow slower than 20% per year.

Next Steps:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for 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, the output can look very different. What is the reason for the share price sitting below the intrinsic value? For Alpha Financial Markets Consulting, we've put together three important items you should further research:

  1. Risks: To that end, you should be aware of the 2 warning signs we've spotted with Alpha Financial Markets Consulting .

  2. Future Earnings: How does AFM's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.

  3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the AIM every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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