I am going to run you through how I calculated the intrinsic value of Mitie Group plc (LSE:MTO) using the discounted cash flow (DCF) method. If you want to learn more about this method, the basis for my calculations can be found in detail in the Simply Wall St analysis model. If you are reading this after December 2017 then I highly recommend you check out the latest calculation for Mitie Group here.

Crunching the numbers

I’ve used the 2-stage growth model, which takes into account the initial higher growth stage of a company’s life cycle and the steadier growth phase over the long run. Firstly, I took the analyst consensus forecast of MTO’s levered free cash flow (FCF) over the next five years and discounted these figures at the cost of equity of 8.3%. When estimates weren’t available, I’ve extrapolated the average annual growth rate over the previous five years, capped at a reasonable level. This resulted in a present value of 5-year cash flow of £199.8M. Keen to understand how I arrived at this number? Read our detailed analysis here.

Above is a visual representation of how MTO’s earnings are expected to move going forward, which should give you an idea of MTO’s outlook. Now we need to determine the terminal value, which accounts for all the future cash flows after the five years. I think it’s suitable to use the 10-year government bond rate of 2.8% as the stable growth rate, which is rightly below GDP growth, but more towards the conservative side. Discounting the terminal value back five years gives us a present value of £679.0M.

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is £878.8M. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value of £2.44, which, compared to the current share price of £1.925, we see that Mitie Group is about right, perhaps slightly undervalued at a 20.98% discount to what it is available for right now.

Next Steps:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For MTO, I’ve put together three important aspects you should further examine:

PS. Simply Wall St does a DCF calculation for every GB stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.