I am going to run you through how I calculated the intrinsic value of Capgemini SE (EPA:CAP) by taking the expected future cash flows and discounting them to today’s 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 August 2018 then I highly recommend you check out the latest calculation for Capgemini by following the link below.
Step by step through the calculation
I’m 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 perpetual stable growth rate. In the first stage we need to estimate the cash flows to the business over the next five years. 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 (€, Millions)||€1.03k||€1.14k||€1.25k||€1.33k||€1.41k|
|Source||Analyst x11||Analyst x11||Analyst x8||Est @ 6.16%||Est @ 6.16%|
|Present Value Discounted @ 8.3%||€952.43||€969.34||€983.61||€964.14||€945.05|
Present Value of 5-year Cash Flow (PVCF)= €4.81b
After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (0.8%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 8.3%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = €1.41b × (1 + 0.8%) ÷ (8.3% – 0.8%) = €18.86b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = €18.86b ÷ ( 1 + 8.3%)5 = €12.66b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is €17.48b. 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 €104.85. Compared to the current share price of €112, the stock is fair value, maybe slightly overvalued at the time of writing.
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 Capgemini 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 8.3%, which is based on a levered beta of 0.816. 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 CAP, there are three relevant factors you should further examine:
- Financial Health: Does CAP 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 CAP’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 CAP? 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 EPA 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.