A look at the fair value of Big Technologies plc (LON: BIG)

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How far is Big Technologies plc (LON: BIG) from its intrinsic value? Using the most recent financial data, we’ll examine whether the stock price is fair by taking the company’s future cash flow forecast and discounting it to today’s value. To this end, we will take advantage of the Discounted Cash Flow (DCF) model. Patterns like these may seem beyond a layman’s comprehension, but they are fairly easy to follow.

We draw your attention to the fact that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.

See our latest analysis for major tech

The calculation

We are going to use a two-step DCF model, which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “steady growth”. To begin with, we need to get cash flow estimates for the next ten years. Since no free cash flow analyst estimate is available, we have extrapolated the previous free cash flow (FCF) from the last reported value of the company. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.

In general, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:

10-year Free Cash Flow (FCF) estimate

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leverage FCF (£, Million) United Kingdom £ 21.6 million United Kingdom £ 27.5million £ 32.8 million United Kingdom £ 37.3 million United Kingdom £ 41.0 million United Kingdom £ 44.0 million United Kingdom £ 46.3 million United Kingdom £ 48.1 million United Kingdom £ 49.6 million £ 50.8 million
Source of estimated growth rate East @ 38.46% Est @ 27.19% Is 19.3% Est @ 13.78% Est @ 9.92% East @ 7.21% East @ 5.32% Is @ 3.99% East @ 3.07% East @ 2.42%
Present value (£, millions) discounted at 5.4% United Kingdom £ 20.5 United Kingdom £ 24.7 United Kingdom £ 28.0 United Kingdom £ 30.2 United Kingdom £ 31.5 United Kingdom £ 32.0 United Kingdom £ 32.0 United Kingdom £ 31.5 United Kingdom £ 30.8 United Kingdom £ 30.0

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = £ 291 million in the UK

The second stage is also known as terminal value, this is the cash flow of the business after the first stage. For a number of reasons, a very conservative growth rate is used that cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (0.9%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 5.4%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = UK £ 51m × (1 + 0.9%) ÷ (5.4% –0.9%) = UK £ 1.1b

Present value of terminal value (PVTV)= TV / (1 + r)ten= UK £ 1.1b ÷ (1 + 5.4%)ten= £ 667 million in the UK

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is £ 958million. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of £ 3.0 UK, the company appears to be roughly at fair value with a discount of 8.8% to the current share price. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.

OBJECTIVE: LARGE discounted cash flows October 30, 2021

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual 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 view big tech 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 5.4%, which is based on a leveraged beta of 0.926. 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.

To move on :

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 business. It is not possible to achieve a rock-solid valuation with a DCF model. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. For large tech, there are three other things you should consider:

  1. Financial health: Does BIG 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 benefits: How does BIG’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth expectations chart.
  3. Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!

PS. The Simply Wall St app performs a daily discounted cash flow assessment for each AIM share. If you want to find the calculation for other actions, just search here.

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 material. Simply Wall St has no position in any of the stocks mentioned.

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