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How far off is Topps Tiles Plc (LON:TPT) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by estimating the company’s future cash flows and discounting them to their present value. I will be using the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not February 2019 then I highly recommend you check out the latest calculation for Topps Tiles by following the link below.
Crunching the numbers
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 begin with we have to get estimates of 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 (£, Millions)||£13.50||£12.42||£13.33||£13.72||£14.13|
|Source||Analyst x3||Analyst x3||Analyst x3||Est @ 2.95%||Est @ 2.95%|
|Present Value Discounted @ 8.25%||£12.48||£10.60||£10.51||£10.00||£9.51|
Present Value of 5-year Cash Flow (PVCF)= UK£53m
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 (1.2%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 8.2%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = UK£14m × (1 + 1.2%) ÷ (8.2% – 1.2%) = UK£204m
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = UK£204m ÷ ( 1 + 8.2%)5 = UK£137m
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 UK£190m. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of £0.98. Relative to the current share price of £0.68, the stock is quite good value at a 31% 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 Topps Tiles 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 8.2%, which is based on a levered beta of 0.800. 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. What is the reason for the share price to differ from the intrinsic value? For TPT, there are three essential factors you should further examine:
- Financial Health: Does TPT 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 TPT’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 TPT? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. Simply Wall St does a DCF calculation for every GB stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see past 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. For errors that warrant correction please contact the editor at firstname.lastname@example.org.