Does the share price for Sinosoft Technology Group Limited (HKG:1297) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value by estimating the company’s 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! 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 August 2018 then I highly recommend you check out the latest calculation for Sinosoft Technology Group by following the link below.
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. I then discount the sum of these cash flows to arrive at a present value estimate.
5-year cash flow estimate
|Levered FCF (CN¥, Millions)||CN¥131.00||CN¥183.50||CN¥216.53||CN¥253.34||CN¥293.87|
|Source||Analyst x2||Analyst x2||Est @ 18%, capped from 18.28%||Est @ 17%, capped from 18.28%||Est @ 16%, capped from 18.28%|
|Present Value Discounted @ 10.74%||CN¥118.30||CN¥149.64||CN¥159.46||CN¥168.48||CN¥176.49|
Present Value of 5-year Cash Flow (PVCF)= CN¥772.4m
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 2.2%. We discount this to today’s value at a cost of equity of 10.7%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = CN¥293.9m × (1 + 2.2%) ÷ (10.7% – 2.2%) = CN¥3.52b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = CN¥3.52b ÷ ( 1 + 10.7%)5 = CN¥2.11b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is CN¥2.89b. The last step is to then 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) then we use the equivalent number. This results in an intrinsic value in the company’s reported currency of CN¥2.36. However, 1297’s primary listing is in China, and 1 share of 1297 in CNY represents 1.152 ( CNY/ HKD) share of SEHK:1297, so the intrinsic value per share in HKD is HK$2.72. Compared to the current share price of HK$2.76, the stock is fair value, maybe slightly overvalued and not available at a discount at this time.
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 Sinosoft Technology 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 10.7%, which is based on a levered beta of 1.094. 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.
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. For 1297, I’ve put together three pertinent aspects you should look at:
- Financial Health: Does 1297 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 1297’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 1297? 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 HKG every 6 hours. If you want to find the calculation for other stocks 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.