Investors Are Undervaluing RWE Aktiengesellschaft (FRA:RWE) By 28%
I am going to run you through how I calculated the intrinsic value of RWE Aktiengesellschaft (DB:RWE) using the discounted cash flow (DCF) method. If you want to learn more about this method, the basis for my calculations can be found in detail in the Simply Wall St analysis model. Also note that this article was written in April 2018 so be sure check the latest calculation for RWE here.
Crunching the numbers
I will be using the 2-stage growth model, which takes into account the initial higher growth stage of a company’s life cycle and the steadier growth phase over the long run. To start off, I use the analyst consensus estimates of RWE’s levered free cash flow (FCF) over the next five years and discounted these figures at the cost of equity of 10.17%. This resulted in a present value of 5-year cash flow of €6.03B. Keen to understand how I arrived at this number? Read our detailed analysis here.
In the visual above, we see how how RWE’s top and bottom lines are expected to move going forward, which should give you an idea of RWE’s outlook. Then, I determine the terminal value, which is the business’s cash flow after the first stage. It’s appropriate to use the 10-year government bond rate of 2.8% as the perpetual growth rate, which is rightly below GDP growth, but more towards the conservative side. The present value of the terminal value after discounting it back five years is €12.28B.
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is €18.31B. The last step is to then divide the equity value by the number of shares outstanding. This results in an intrinsic value of €29.79, which, compared to the current share price of €21.45, we see that RWE is about right, perhaps slightly undervalued at a 27.99% discount to what it is available for right now.
Next Steps:
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For RWE, I’ve compiled three important factors you should further research:
Financial Health: Does RWE 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 RWE’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 RWE? 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 DB every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
