Calculating The Intrinsic Value Of Rave Restaurant Group, Inc. (NASDAQ:RAVE)
Key Insights
Using the 2 Stage Free Cash Flow to Equity, Rave Restaurant Group fair value estimate is US$2.35
Rave Restaurant Group's US$1.98 share price indicates it is trading at similar levels as its fair value estimate
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Rave Restaurant Group, Inc. (NASDAQ:RAVE) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
Check out our latest analysis for Rave Restaurant Group
The Method
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$1.88m | US$1.88m | US$1.90m | US$1.92m | US$1.95m | US$1.99m | US$2.02m | US$2.07m | US$2.11m | US$2.16m |
Growth Rate Estimate Source | Est @ -0.67% | Est @ 0.22% | Est @ 0.84% | Est @ 1.28% | Est @ 1.58% | Est @ 1.79% | Est @ 1.94% | Est @ 2.05% | Est @ 2.12% | Est @ 2.17% |
Present Value ($, Millions) Discounted @ 7.5% | US$1.7 | US$1.6 | US$1.5 | US$1.4 | US$1.4 | US$1.3 | US$1.2 | US$1.2 | US$1.1 | US$1.1 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$14m
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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 7.5%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$2.2m× (1 + 2.3%) ÷ (7.5%– 2.3%) = US$43m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$43m÷ ( 1 + 7.5%)10= US$21m
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$34m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$2.0, the company appears about fair value at a 16% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
The 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 Rave Restaurant 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 7.5%, which is based on a levered beta of 1.123. 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 Rave Restaurant Group
Strength
Currently debt free.
Weakness
Earnings declined over the past year.
Shareholders have been diluted in the past year.
Opportunity
Current share price is below our estimate of fair value.
Significant insider buying over the past 3 months.
Lack of analyst coverage makes it difficult to determine RAVE's earnings prospects.
Threat
No apparent threats visible for RAVE.
Moving On:
Although the valuation of a company is important, 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Rave Restaurant Group, we've put together three relevant elements you should explore:
Risks: You should be aware of the 3 warning signs for Rave Restaurant Group we've uncovered before considering an investment in the company.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for RAVE's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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 American 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.
