In this article, we will estimate the intrinsic value of Boab Metals Limited (ASX:BML) by taking the company’s expected future cash flows and discounting them to present value. We will use the Discounted Cash Flow (DCF) model for this purpose. This may sound complicated, but it’s actually quite simple!
We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
Check out our latest analysis for Boab Metals
What is the estimated valuation?
We have to calculate the value of Boab Metals slightly differently than other stocks because it is a metals and mining company. In this approach, dividends per share (DPS) are used, because free cash flow is difficult to estimate and often not reported by analysts. This often underestimates the value of a stock, but it can still be a good comparison against competitors. We use Gordon’s growth model, which assumes that the dividend will grow in perpetuity at a rate that can be sustained. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a company’s Gross Domestic Product (GDP). In this case, we used the 5-year average of the 10-year government bond yield (1.8%). The expected dividend per share is then discounted to its present value at a cost of equity of 7.1%. Compared to the current share price of AU$0.3, the company appears to be about fair value at a 14% discount to the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep that in mind.
Value per share = Expected dividend per share / (Discount rate – Perpetual growth rate)
= AU$0.02 / (7.1% – 1.8%)
Now, 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 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 complete picture of a company’s potential performance. Since we consider Boab Metals 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 7.1%, which is based on a leveraged beta of 1.246. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Let’s move on :
Valuation is only one side of the coin in terms of crafting your investment thesis, and it shouldn’t be the only metric you look at when researching a company. DCF models are not the be-all and end-all of 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 significantly change the overall result. For Boab Metals, there are three additional aspects you should explore:
- Risks: Take for example the ubiquitous specter of investment risk. We have identified 3 warning signs with Boab Metals (at least 1 which we don’t like too much), and understanding them should be part of your investment process.
- Future earnings: How does BML’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!
PS. The Simply Wall St app performs a discounted cash flow valuation for every stock on the ASX every day. If you want to find the calculation for other stocks, 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 only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.