I am going to run you through how I calculated the intrinsic value of CanWel Building Materials Group Ltd (TSE:CWX) by taking the expected future cash flows and discounting them to their present value. This is done using the discounted cash flows (DCF) model. It may sound complicated, but actually it is quite simple! Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not December 2018 then I highly recommend you check out the latest calculation for CanWel Building Materials Group by following the link below.
Step by step through the calculation
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 start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
5-year cash flow estimate
|Levered FCF (CA$, Millions)||CA$37.50||CA$46.00||CA$51.92||CA$58.60||CA$66.15|
|Source||Analyst x2||Analyst x1||Est @ 12.87%||Est @ 12.87%||Est @ 12.87%|
|Present Value Discounted @ 14.88%||CA$32.64||CA$34.85||CA$34.24||CA$33.64||CA$33.05|
Present Value of 5-year Cash Flow (PVCF)= CA$168m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.3%. We discount this to today’s value at a cost of equity of 14.9%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = CA$66m × (1 + 2.3%) ÷ (14.9% – 2.3%) = CA$540m
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = CA$540m ÷ ( 1 + 14.9%)5 = CA$270m
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is CA$438m. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of CA$5.64. Relative to the current share price of CA$4.8, the stock is about right, perhaps slightly undervalued at a 15% discount to what it is available for right now.
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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at CanWel Building Materials Group as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 14.9%, which is based on a levered beta of 1.637. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. For CWX, I’ve compiled three relevant aspects you should further examine:
- Financial Health: Does CWX have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does CWX’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.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of CWX? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. The Simply Wall St app conducts a discounted cash flow for every stock on the TSE every 6 hours. If you want to find the calculation for other stocks just search here.
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The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.