Over in this thread I wrote up some of my investigations into valuing a stock price, by using DCFs (discounted cash flows), which involves summarising estimates of annual FCFps (free cash flows per share), and selecting a discount rate (the investors desired rate of return/risk factor, or the company's "cost of capital"), and bringing each cash flow back to present day value in order to result in a final share price estimate.
As many note the DCF method has 2 major failings:
1. estimating FCF growth over the forecasting period and
2. selection of an appropriate discount rate.
I'm afraid to say that the method I'm writing about in this thread, suffers from both of the above flaws, but since it's something I've read about and experimented with, I'm going to write it down, in order to compare and contrast with other techniques.
The method is as follows:
1. Form a free cash flow based value, using the DCFs from forecast growth rates over the next 10 years.
2. Derive a terminal value by using the projected equity value, i.e. book value per share, after 10 years, discounted back.
3. Add the 2 values from 1. and 2. together
This method is based on a method I read in this book, except in the book discounted dividends are used. However, discounted cash flows, seem more appropriate, since they will cater for firms with differing dividend policies etc.
As usual I used Marshalls (MSLH) as my example. Here goes, first the DCFs see the earlier thread for where the cash flows and growth rates come from:
FCF Growth Year DFCF
0.18 0.12 0
0.20 0.12 1 0.19
0.23 0.12 2 0.20
0.25 0.05 3 0.21
0.27 0.05 4 0.20
0.28 0.025 5 0.20
0.29 0.025 6 0.19
0.29 0.025 7 0.18
0.30 0.025 8 0.17
0.31 0.025 9 0.17
0.32 10 0.16
============================
TOTAL 1.87
So in the above I've used initial FCFps=18p, and the growth rate initially at 0.12, then stepping down through 0.05, to 0.025. Using a discount rate of 0.07, the sum of these flows comes out as being 1.87.
Now for the BVps (book value per share); I looked at the Total equity (net asset value) for the years 2013-17, and the number of diluted shares, in £1000 and 1000s of shares respectively:
Year 2013 2014 2015 2016 2017
N/shares 195743 196116 199667 200692 198903
Equity 175432 181894 192718 217121 237627
BVps 0.896 0.928 0.965 1.082 1.195
Using CAGR I deduced the BVps annual growth to be 0.075. I then applied this growth rate to the last BVps i.e. 2017s figure of £1.195 per share. And using the following formula:
Future value = Present value * (1 + growth rate)^10
I figured a value of £2.46 of BVps after 10 years...however discounting this value (using 0.07 as the rate) leaves us with only £1.25 per share toward present day value.
So adding the £1.87 from the DCFs and £1.25 from the BV, gives only £3.12 per share.
Since this value is less than the £5.23 estimated in the earlier thread using pure DCFs, I'm assuming this is due the companies like Marshalls (and a great many others) being valued more on "what they can do the assets", rather than solely the current assumed worth of those assets.
Any comments, critique etc. welcomed
Matt