Want To Know Capgemini SE’s (EPA:CAP) True Stock Value?
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With so many different financial models generating different conclusions, choosing the most relevant one to value a company can be daunting. In the case of Capgemini SE’s (EPA:CAP), my discounted cash flow (DCF) model tells me that Capgemini SE’s (EPA:CAP) is overvalued by 11.08%; however, my relative valuation metrics tell me that Capgemini SE’s (EPA:CAP) is undervalued by 1.01%. Which model do I listen to and more importantly why?
See our latest analysis for Capgemini
Examining intrinsic valuation
Since forecasting future free cash flows (FCFs) accurately into the future is often difficult and a highly subjective task, I’ve used analysts’ FCF forecasts as a starting point for my DCF. For those less familiar with valuation, the assumption behind the DCF is that a firm’s intrinsic value is equal to the sum of all its future FCFs, which is why quality forecasts are a high priority. When I discount all of CAP’s future FCFs by 10%, I obtain an equity value of €€14b, then 162.34k shares outstanding are divided through. This results in an intrinsic value of €89.31. Check out the source of my intrinsic value here.,
But how dependable is this value? Since it is generally impossible to forecast FCFs indefinitely, it is common for analysts to forecast for an explicit forecast horizon and then assume the company is mature by the end of that period and in a stable growth phase. CAP’s final year FCF growth rate of -10.08%, is too low. If this assumption held true, CAP would shrink to a point where it would cease to exist very soon, which is a highly unlikely outcome. To improve our DCF analysis, we could extend the terminal year until FCF growth moderates to a more sustainable level around 1% to 5%. The downside is that forecasts are less reliable the further into the future they are.
A closer look at relative valuation
While DCF models sum up future FCFs, relative valuation models are based on the idea that investors should pay the same price for two companies with identical risk and return profiles. Since the biggest dilemma is finding companies that are similar to CAP, a viable proxy would be the overall IT industry itself. Obtaining the fair value of CAP through relative valuation is quite straightforward. We simply multiply CAP’s earnings by the industry’s P/E ratio, which gives us a share price of €100.2 that implies CAP is currently undervalued. However, is this conclusion robust enough for us to use?
One quick way of finding out is to see if CAP shares a similar growth profile to the overall IT industry we are comparing it to. With a projected earnings growth rate of 17.53% for next year, CAP has a similar growth profile when compared with the IT industry, which is projected to grow at 21.32%. This demonstrates that the IT industry is a good proxy for CAP and ideal for our relative valuation.
What Model Should I Listen To?
Unfortunately, both models have their own merits and deficiencies, which means the truth lies somewhere in the middle. While intrinsic valuation is immune from market irrationality and mispricing, it is highly exposed to forecasting error. On the other hand, relative valuation is easy to calculate but affected by overall market mispricing. For example, relative valuation would not have been an effective tool to value a technology company at the height of the dotcom bubble in 2000. Ultimately, investors should derive their final valuation based off both models. I encourage you to weight each model depending on your preferences to calculate a weighted average target price.
Next Steps:
For CAP, I’ve compiled three pertinent factors you should further examine:
Financial Health: Does CAP 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 CAP’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 CAP? 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 EPA 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 editorial-team@simplywallst.com.
