Today I will be providing a simple run-through of the discounted cash flows (DCF) method to estimate the attractiveness of Telford Homes Plc (AIM:TEF) as an investment opportunity. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this after February 2018 then I highly recommend you check out the latest calculation for Telford Homes here.
Crunching the numbers
I use what is known as the 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the initial phase has higher growth rates that plateau over time. Firstly, I took the analyst consensus estimates of TEF’s levered free cash flow (FCF) over the next five years and discounted these figures at the rate of 8.3%. When estimates weren’t available, I’ve extrapolated the average annual growth rate over the previous five years, capped at a reasonable level. This resulted in a present value of 5-year cash flow of £-48.8M. Want to know how I arrived at this number? Check out our detailed analysis here.
The infographic above illustrates how TEF’s top and bottom lines are expected to move going forward, which should give you some color on TEF’s outlook. Secondly, I determine the terminal value, which accounts for all the future cash flows after the five years. 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 £455.0M.
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is £406.2M. To get the intrinsic value per share, we divide this by the total number of shares outstanding. This results in an intrinsic value of £5.42, which, compared to the current share price of £3.98, we find that Telford Homes is about right, perhaps slightly undervalued at a 26.53% discount to what it is available for right now.
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. What is the reason for the share price to differ from the intrinsic value? For TEF, there are three essential factors you should look at:
- 1. Financial Health: Does TEF 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.
- 2. Future Earnings: How does TEF’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.
- 2. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of TEF? 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 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.