Today we will walk through one way to estimate the intrinsic value of Yuexiu Property Company Limited (HKG:123) by taking the company’s expected future cash flows and discounting them to the present value. This will be done using the discounted cash flow (DCF) model. Before you think you can’t figure it out, just read on! It’s actually a lot less complex than you might imagine.
Remember though that there are many ways to estimate the value of a business and a DCF is just one method. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.
See our latest analysis for the Yuexiu property
What is the estimated valuation?
As Yuexiu Property operates in the real estate 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. 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 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 present value at a cost of equity of 8.2%. Compared to the current share price of HK$8.3, the company looks slightly undervalued at a 23% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
Value per share = Expected dividend per share / (Discount rate – Perpetual growth rate)
= CN¥0.6 / (8.2% – 1.5%)
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. If you disagree with these results, try the math yourself and play around with the 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 Yuexiu Property 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 8.2%, which is based on a leveraged beta of 1.380. 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. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or 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. Can we understand why the company is trading at a discount to its intrinsic value? For the Yuexiu property, we have compiled three relevant items you should check out:
- Risks: To this end, you should inquire about the 3 warning signs we spotted with Yuexiu Property (including 1 which is a little worrying).
- Future earnings: How does 123’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 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 Hong Kong stock daily, so if you want to find the intrinsic value of any other stock, just 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.