Domain Holdings Australia Limited (ASX:DHG) Shares Could Be 41% Below Their Intrinsic Value Estimate




  • In Business
  • 2022-09-30 22:56:38Z
  • By Simply Wall St.
 

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Domain Holdings Australia Limited (ASX:DHG) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Domain Holdings Australia

The Method

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$1.0b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (1.8%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 6.6%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r - g) = AU$211m× (1 + 1.8%) ÷ (6.6%- 1.8%) = AU$4.5b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$4.5b÷ ( 1 + 6.6%)10= AU$2.4b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is AU$3.4b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of AU$3.2, the company appears quite good value at a 41% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

Important Assumptions

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 evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Domain Holdings Australia 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 accounts for debt. In this calculation we've used 6.6%, which is based on a levered beta of 1.118. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Moving On:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Domain Holdings Australia, we've compiled three relevant elements you should consider:

  1. Risks: To that end, you should be aware of the 1 warning sign we've spotted with Domain Holdings Australia .

  2. Future Earnings: How does DHG's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.

  3. Other Solid Businesses: 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 business fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the ASX every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Join A Paid User Research Session
You'll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here

COMMENTS

More Related News

Estimating The Fair Value Of Headlam Group plc (LON:HEAD)
Estimating The Fair Value Of Headlam Group plc (LON:HEAD)

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Headlam Group plc...

Is Now An Opportune Moment To Examine SDI Group plc (LON:SDI)?
Is Now An Opportune Moment To Examine SDI Group plc (LON:SDI)?

While SDI Group plc ( LON:SDI ) might not be the most widely known stock at the moment, it saw a double-digit share...

Young & Co.
Young & Co.'s Brewery, P.L.C.'s (LON:YNGA) Intrinsic Value Is Potentially 31% Above Its Share Price

How far off is Young & Co.'s Brewery, P.L.C. ( LON:YNGA ) from its intrinsic value? Using the most recent financial...

At UK£1.75, Is It Time To Put Warpaint London PLC (LON:W7L) On Your Watch List?
At UK£1.75, Is It Time To Put Warpaint London PLC (LON:W7L) On Your Watch List?

While Warpaint London PLC ( LON:W7L ) might not be the most widely known stock at the moment, it saw a significant...

EML Payments Limited
EML Payments Limited's (ASX:EML) Intrinsic Value Is Potentially 88% Above Its Share Price

In this article we are going to estimate the intrinsic value of EML Payments Limited ( ASX:EML ) by taking the expected...

Leave a Comment

Your email address will not be published. Required fields are marked with *

Cancel reply

Comments

Top News: Business