Calculating The Fair Value Of Scott Technology Limited (NZSE:SCT)

editorial-team@simplywallst.com (Simply Wall St)

Thu, Jan 30, 2025, 6:12 PM 5 min read

Scott Technology's estimated fair value is NZ$2.07 based on Dividend Discount Model
Scott Technology's NZ$2.20 share price indicates it is trading at similar levels as its fair value estimate
Scott Technology's peers seem to be trading at a higher premium to fair value based onthe industry average of -10%

Does the January share price for Scott Technology Limited (NZSE:SCT) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Scott Technology

Is Scott Technology Fairly Valued?

As Scott Technology operates in the machinery sector, we need to calculate the intrinsic value slightly differently. In this approach dividends per share (DPS) are used, as 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 typically underestimate the value of the stock. We use the Gordon Growth Model, which assumes dividend will grow into 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 (3.0%). The expected dividend per share is then discounted to today's value at a cost of equity of 7.8%. Compared to the current share price of NZ$2.2, the company appears around fair value at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

Value Per Share = Expected Dividend Per Share / (Discount Rate - Perpetual Growth Rate)

= NZ$0.1 / (7.8% – 3.0%)

= NZ$2.1

dcf — NZSE:SCT Discounted Cash Flow January 31st 2025

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 Scott Technology 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 7.8%, which is based on a levered beta of 1.172. 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.

SWOT Analysis for Scott Technology

Strength

Debt is well covered by earnings.

Weakness

Earnings declined over the past year.

Dividend is low compared to the top 25% of dividend payers in the Machinery market.

Opportunity

Annual earnings are forecast to grow faster than the New Zealander market.

Good value based on P/E ratio compared to estimated Fair P/E ratio.

Threat

Debt is not well covered by operating cash flow.

Paying a dividend but company has no free cash flows.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for 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, the output can look very different. For Scott Technology, there are three additional aspects you should assess:

Risks: To that end, you should be aware of the 3 warning signs we've spotted with Scott Technology .
Future Earnings: How does SCT'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.
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 NZSE every day. If you want to find the calculation for other stocks just search here.

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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.