Does the December share price for Industria de Diseño Textil, SA (BME: ITX) reflect its true value? Today we’re going to estimate the intrinsic value of the stock by projecting its future cash flows and then discounting them to today’s value. Our analysis will use the discounted cash flow (DCF) model. It may sound complicated, but it’s actually quite simple!
We generally think of a business’s value as the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. Anyone interested in learning a bit more about intrinsic value should read the Simply Wall St.
Check out our latest review for Industria de Diseño Textil
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth, and the second stage is lower growth stage. To begin with, we need to get cash flow estimates for the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. 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
|Leverage FCF (€, Millions)||4.97 billion euros||4.98 billion euros||5.02 billion euros||5.39 billion euros||5.13 billion euros||4.98 billion euros||€ 4.90 billion||4.85 billion euros||4.83 billion euros||4.83 billion euros|
|Source of estimated growth rate||Analyst x16||Analyst x16||Analyst x13||Analyst x4||Analyst x2||East @ -2.91%||Is @ -1.76%||East @ -0.96%||East @ -0.4%||East @ -0.01%|
|Present value (€, Millions) discounted at 7.8%||€ 4.6k||€ 4.3k||4.0 K €||4.0 K €||€ 3.5k||€ 3.2k||€ 2.9k||€ 2.7k||€ 2.5k||€ 2.3k|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = € 34bn
We now need to calculate the Terminal Value, which takes into account all future cash flows after this ten year period. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 0.9%. We discount the terminal cash flows to their present value at a cost of equity of 7.8%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = € 4.8 billion × (1 + 0.9%) ÷ (7.8% – 0.9%) = € 71 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= € 71bn ÷ (1 + 7.8%)ten= 33 billion euros
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the Total Equity Value, which in this case is 67 billion euros. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current price of 28.6 €, the company appears potentially overvalued at the time of writing. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
We draw your attention to the fact 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 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 consider Industria de Diseño Textil as a potential shareholder, 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 7.8%, which is based on a leveraged beta of 1.202. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average 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 :
While valuing a business is important, it’s just one of the many factors you need to assess for 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, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. Why is intrinsic value lower than the current share price? For Industria de Diseño Textil there are three relevant aspects that you should consider further:
- Risks: Concrete example, we have spotted 1 warning sign for Industria de Diseño Textil you must be aware.
- Future benefits: How does ITX’s growth rate compare to its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
- Other strong companies: 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 trading fundamentals to see if there are other companies you may not have considered!
PS. Simply Wall St updates its DCF calculation for every Spanish stock every day, so if you want to find the intrinsic value of any other stock just search here.
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.
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 any stock 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 documents. Simply Wall St has no position in any of the stocks mentioned.