Does the September share price for Shenzhen Expressway Company Limited (HKG: 548) reflect its true value? Today we’re going to estimate the intrinsic value of the stock by taking the company’s future cash flow forecast and discounting it to today’s value. One way to do this is to use the Discounted Cash Flow (DCF) model. There really isn’t much to do, although it might seem quite complex.
There are many ways businesses can be assessed, so we would like to point out that a DCF is not perfect for all situations. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something that interests you.
See our latest analysis for the Shenzhen Expressway
What is the estimated valuation?
We have to calculate the value of Shenzhen Expressway slightly different from other stocks because it is an infrastructure company. Instead of using free cash flow, which is difficult to estimate and often unreported by industry analysts, dividend payments per share (DPS) are used. Unless a company pays out the majority of its FCF as a dividend, this method will generally underestimate the value of the stock. We use Gordon’s growth model, which assumes that the dividend will grow in perpetuity at a rate that can be sustained. The dividend is expected to grow at an annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.5%. We then discount this figure to today’s value at a cost of equity of 10%. Compared to the current share price of HK $ 7.2, the company appears to be roughly at fair value with a 16% discount to the current share price. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
Value per share = Expected dividend per share / (Discount rate – Perpetual growth rate)
= CN ¥ 0.6 / (10% – 1.5%)
= 8.6 HK $
The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we consider Shenzhen Expressway 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 takes debt into account. In this calculation, we used 10%, which is based on a leveraged beta of 1.641. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
While valuing a business is important, it’s just one of the many factors you need to assess for a business. DCF models are not the ultimate solution for investment valuation. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For the Shenzhen Expressway, there are three other things to consider:
- Risks: Every company has them, and we have spotted 2 warning signs for the Shenzhen highway (1 of which cannot be ignored!) that you should know.
- Future benefits: How does the growth rate of 548 compare to that of its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
- Other strong companies: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you may not have considered!
PS. Simply Wall St updates its DCF calculation for every Hong Kong stock every day, so if you want to find the intrinsic value of any other stock just search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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