Today we’re going to review one way to estimate the intrinsic value of Besunyen Holdings Company Limited (HKG: 926) by estimating the company’s future cash flows and discounting them to their present value. One way to do this is to use the Discounted Cash Flow (DCF) model. Don’t be put off by the lingo, the math is actually pretty straightforward.
There are many ways businesses can be assessed, so we would like to point out that a DCF is not perfect for all situations. If you still have burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
Check out our latest analysis for Besunyen Holdings
Is Besunyen Holdings correctly valued?
As Besunyen Holdings operates in the food business, we have to calculate intrinsic value slightly differently. In this approach, dividends per share (DPS) are used because free cash flow is difficult to estimate and often not reported by analysts. Unless a company pays out the majority of its FCF as a dividend, this method will generally underestimate the value of the stock. The “Gordon Growth Model” is used, which simply assumes that dividend payments will continue to increase at a sustainable growth rate forever. For a number of reasons, a very conservative growth rate is used that 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 (1.5%). The expected dividend per share is then discounted to its current value at a cost of equity of 5.8%. Compared to the current share price of HK $ 0.4, the company appears to be 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 another galaxy. Keep this in mind.
Value per share = Expected dividend per share / (Discount rate – Perpetual growth rate)
= CN ¥ 0.03 / (5.8% – 1.5%)
= HK $ 0.3
We would like to stress that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play with them. 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 view Besunyen Holdings 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 into account debt. In this calculation, we used 5.8%, which is based on a leverage beta of 0.800. 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 from globally comparable companies, with a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.
While a business valuation is important, it shouldn’t be the only metric you look at when researching a business. The DCF model is not a perfect equity valuation tool. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. For Besunyen Holdings, you need to consider three relevant factors:
- Risks: Concrete example, we have spotted 5 warning signs for Besunyen Holdings you must be aware.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!
- Other picks from top analysts: Interested in seeing what analysts think? Take a look at our interactive list of analysts’ top stock picks to find out what they think might have a compelling outlook for the future!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each SEHK share. If you want to find the calculation for other actions, just search here.
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