Are Oxford Metrics plc (LON:OMG) Investors Paying Above The Intrinsic Value?
Key Insights
Oxford Metrics' estimated fair value is UK£0.64 based on 2 Stage Free Cash Flow to Equity
Oxford Metrics is estimated to be 31% overvalued based on current share price of UK£0.84
Our fair value estimate is 56% lower than Oxford Metrics' analyst price target of UK£1.45
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Oxford Metrics plc (LON:OMG) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. It may sound complicated, but actually it is quite simple!
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 Oxford Metrics
Step By Step Through The Calculation
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. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or 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 discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF (£, Millions) | UK£6.40m | UK£5.87m | UK£5.56m | UK£5.37m | UK£5.27m | UK£5.22m | UK£5.21m | UK£5.22m | UK£5.25m | UK£5.29m |
Growth Rate Estimate Source | Analyst x2 | Est @ -8.24% | Est @ -5.36% | Est @ -3.34% | Est @ -1.92% | Est @ -0.93% | Est @ -0.24% | Est @ 0.25% | Est @ 0.59% | Est @ 0.83% |
Present Value (£, Millions) Discounted @ 7.3% | UK£6.0 | UK£5.1 | UK£4.5 | UK£4.1 | UK£3.7 | UK£3.4 | UK£3.2 | UK£3.0 | UK£2.8 | UK£2.6 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£38m
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 1.4%. We discount the terminal cash flows to today's value at a cost of equity of 7.3%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = UK£5.3m× (1 + 1.4%) ÷ (7.3%– 1.4%) = UK£91m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£91m÷ ( 1 + 7.3%)10= UK£45m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£84m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of UK£0.8, the company appears reasonably expensive at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
Important Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. 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 Oxford Metrics 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 7.3%, which is based on a levered beta of 0.996. 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 Oxford Metrics
Strength
Earnings growth over the past year exceeded the industry.
Currently debt free.
Weakness
Dividend is low compared to the top 25% of dividend payers in the Software market.
Current share price is above our estimate of fair value.
Opportunity
Annual revenue is forecast to grow faster than the British market.
Threat
Paying a dividend but company has no free cash flows.
Revenue is forecast to grow slower than 20% per year.
Moving On:
Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a premium to intrinsic value? For Oxford Metrics, we've put together three additional aspects you should further examine:
Risks: Case in point, we've spotted 2 warning signs for Oxford Metrics you should be aware of, and 1 of them is potentially serious.
Future Earnings: How does OMG'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: Do you like a good all-rounder? 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 valuation for every stock on the AIM every day. If you want to find the calculation for other stocks 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.
