Does TeamLease Services Limited (NSE: TEAMLEASE) share price in May reflect what it is really worth? Today we are going to estimate the intrinsic value of the stock by taking the expected future cash flows and discounting them to the present value. We will use the Discounted Cash Flow (DCF) model for this purpose. Before you think you can’t figure it out, just read on! It’s actually a lot less complex than you might imagine.
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. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.
Check out our latest analysis for TeamLease Services
We use what is called a 2-stage model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. To begin with, we need to obtain cash flow estimates for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported 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 more in early years than in later years.
Generally, 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 present value:
10-Year Free Cash Flow (FCF) Forecast
|Leveraged FCF (₹, million)||₹733.2 million||₹1.84 billion||₹1.81b||₹2.37 billion||₹3.29 billion||₹3.84 billion||₹4.36b||₹4.87 billion||₹5.37b||₹5.86b|
|Growth rate estimate Source||Analyst x5||Analyst x6||Analyst x7||Analyst x2||Analyst x1||Is at 16.79%||Is at 13.77%||Is at 11.66%||Is at 10.18%||Is at 9.14%|
|Present value (₹, million) discounted at 12%||₹653||₹1.5k||₹1,300||₹1.5k||₹1.8k||₹1,900||₹1,900||₹1,900||₹1,900||₹1.8k|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) =₹16b
We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. For a number of reasons, a very conservative growth rate is used which 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 (6.7%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 12%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = ₹5.9b × (1 + 6.7%) ÷ (12%–6.7%) = ₹113b
Present value of terminal value (PVTV)= TV / (1 + r)ten= ₹113b÷ ( 1 + 12%)ten= ₹35b
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 ₹52 billion. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of ₹3.3k, the company appears around fair value at the time of writing. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in a different galaxy. Keep that in mind.
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play around with them. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider TeamLease Services 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 12%, which is based on a leveraged beta of 0.865. 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.
Although important, the DCF calculation is just one of many factors you need to assess for a business. 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?” If a company grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output may be very different. For TeamLease Services, we have compiled three additional items that you should consider in more detail:
- Risks: For this purpose, you must know the 3 warning signs we spotted with TeamLease Services.
- Management:Did insiders increase their shares to take advantage of market sentiment regarding TEAMLEASE’s future prospects? View our management and board analysis with insights into CEO compensation and governance factors.
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
PS. Simply Wall St updates its DCF calculation for every Indian stock every day, so if you want to find the intrinsic value of any other stock, just search here.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email 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 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.