Today we’ll do a simple run through of a valuation method used to estimate the attractiveness of Vistry Group PLC (LON:VTY) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. There’s really not all that much to it, even though it might appear quite complex.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Check out our latest analysis for Vistry Group
Crunching The Numbers
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren’t available we extrapolate the previous free cash flow (FCF) from the last estimate or 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 need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
|Levered FCF (£, Millions)||UK£205.3m||UK£257.7m||UK£30.0m||UK£197.0m||UK£177.4m||UK£165.6m||UK£158.3m||UK£153.9m||UK£151.4m||UK£150.1m|
|Growth Rate Estimate Source||Analyst x8||Analyst x7||Analyst x2||Analyst x1||Est @ -9.96%||Est @ -6.67%||Est @ -4.37%||Est @ -2.76%||Est @ -1.64%||Est @ -0.85%|
|Present Value (£, Millions) Discounted @ 8.3%||UK£190||UK£220||UK£23.6||UK£143||UK£119||UK£103||UK£90.6||UK£81.4||UK£73.9||UK£67.6|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£1.1b
The second stage is also known as Terminal Value, this is the business’s cash flow after 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 1.0%. We discount the terminal cash flows to today’s value at a cost of equity of 8.3%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = UK£150m× (1 + 1.0%) ÷ (8.3%– 1.0%) = UK£2.1b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£2.1b÷ ( 1 + 8.3%)10= UK£935m
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is UK£2.0b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of UK£6.4, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula – garbage in, garbage out.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don’t agree with these result, have a go at the calculation yourself and play with the 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 Vistry Group 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 8.3%, which is based on a levered beta of 1.151. 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.
SWOT Analysis for Vistry Group
- Debt is not viewed as a risk.
- Dividend is in the top 25% of dividend payers in the market.
- Earnings growth over the past year underperformed the Consumer Durables industry.
- Shareholders have been diluted in the past year.
- Annual revenue is forecast to grow faster than the British market.
- Good value based on P/E ratio compared to estimated Fair P/E ratio.
- Significant insider buying over the past 3 months.
- Dividends are not covered by cash flow.
- Annual earnings are forecast to grow slower than the British market.
Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company’s cost of equity or the risk free rate can significantly impact the valuation. For Vistry Group, there are three additional elements you should look at:
- Risks: For example, we’ve discovered 2 warning signs for Vistry Group (1 can’t be ignored!) that you should be aware of before investing here.
- Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for VTY’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- Other Solid Businesses: 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 business fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the LSE every day. If you want to find the calculation for other stocks just search here.
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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.