Today we will run through one way of estimating the intrinsic value of Madhav Marbles and Granites Limited (NSE:MADHAV) 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!
Remember though, that there are many ways to estimate a company’s value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
What’s the estimated valuation?
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 start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company’s last 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) estimate
|Levered FCF (₹, Millions)||₹25.6m||₹28.5m||₹31.2m||₹34.0m||₹36.7m||₹39.6m||₹42.5m||₹45.6m||₹48.8m||₹52.2m|
|Growth Rate Estimate Source||Est @ 12.76%||Est @ 10.95%||Est @ 9.69%||Est @ 8.8%||Est @ 8.18%||Est @ 7.74%||Est @ 7.44%||Est @ 7.23%||Est @ 7.08%||Est @ 6.97%|
|Present Value (₹, Millions) Discounted @ 14%||₹22.5||₹22.0||₹21.2||₹20.3||₹19.3||₹18.3||₹17.3||₹16.3||₹15.3||₹14.4|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹187m
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 6.7%. We discount the terminal cash flows to today’s value at a cost of equity of 14%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = ₹52m× (1 + 6.7%) ÷ (14%– 6.7%) = ₹797m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= ₹797m÷ ( 1 + 14%)10= ₹220m
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹407m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of ₹52.6, the company appears around fair value 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.
We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 Madhav Marbles and Granites 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 14%, which is based on a levered beta of 1.089. 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.
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. It’s not possible to obtain a foolproof valuation with a DCF model. Preferably you’d apply different cases and assumptions and see how they would impact the company’s valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Madhav Marbles and Granites, we’ve put together three relevant elements you should look at:
- Risks: Case in point, we’ve spotted 3 warning signs for Madhav Marbles and Granites you should be aware of, and 2 of them are a bit unpleasant.
- Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for MADHAV’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- 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 NSEI every day. If you want to find the calculation for other stocks just search here.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.