Calculating The Fair Value Of Aptitude Software Group plc (LON:APTD)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Aptitude Software Group fair value estimate is UK£3.20

• Aptitude Software Group's UK£2.99 share price indicates it is trading at similar levels as its fair value estimate

• Analyst price target for APTD is UK£5.22, which is 63% above our fair value estimate

In this article we are going to estimate the intrinsic value of Aptitude Software Group plc (LON:APTD) by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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.

See our latest analysis for Aptitude Software Group

Is Aptitude Software Group Fairly Valued?

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate 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.

Generally we assume that a dollar today is more valuable 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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (£, Millions)	UK£9.87m	UK£10.5m	UK£11.0m	UK£11.3m	UK£11.7m	UK£12.0m	UK£12.2m	UK£12.4m	UK£12.7m	UK£12.9m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Est @ 4.42%	Est @ 3.51%	Est @ 2.87%	Est @ 2.42%	Est @ 2.11%	Est @ 1.89%	Est @ 1.74%	Est @ 1.63%
Present Value (£, Millions) Discounted @ 7.4%	UK£9.2	UK£9.1	UK£8.8	UK£8.5	UK£8.2	UK£7.8	UK£7.4	UK£7.0	UK£6.6	UK£6.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£79m

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 1.4%. We discount the terminal cash flows to today's value at a cost of equity of 7.4%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£13m× (1 + 1.4%) ÷ (7.4%– 1.4%) = UK£215m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£215m÷ ( 1 + 7.4%)¹⁰= UK£105m

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£184m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£3.0, the company appears about fair value at a 6.6% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf

Important Assumptions

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 inputs, I recommend redoing the calculations yourself and playing with them. 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 Aptitude Software 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 accounts for debt. In this calculation we've used 7.4%, which is based on a levered beta of 1.026. 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 Aptitude Software Group

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 Software market.

Opportunity

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

• Current share price is below our estimate of fair value.

Threat

• Dividends are not covered by earnings.

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

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to 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 significantly impact the valuation. For Aptitude Software Group, we've put together three additional items you should look at:

1. Risks: We feel that you should assess the 2 warning signs for Aptitude Software Group we've flagged before making an investment in the company.

2. Future Earnings: How does APTD'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. Simply Wall St updates its DCF calculation for every British stock every day, so if you want to find the intrinsic value of any other stock just search here.

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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.