I am going to run you through how I calculated the intrinsic value of REA Group Limited (ASX:REA) 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 REA Group here.
Is REA fairly valued?
I’ve used the 2-stage growth model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the initial phase has higher growth rates that plateau over time. To start off, I pulled together the analyst consensus estimates of REA’s levered free cash flow (FCF) over the next five years and discounted these figures at the cost of equity of 8.55%. This resulted in a present value of 5-year cash flow of A$1,398.8M. Keen to know how I arrived at this number? Read our detailed analysis here.
Above is a visual representation of how REA’s top and bottom lines are expected to move in the future, which should give you some color on REA’s outlook. Secondly, I calculate the terminal value, which accounts for all the future cash flows after the five years. It’s appropriate to use the 10-year government bond rate of 2.8% as the perpetual growth rate, which is rightly below GDP growth, but more towards the conservative side. After discounting the terminal value back five years, the present value becomes A$5,402.8M.
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is A$6,801.6M. The last step is to then divide the equity value by the number of shares outstanding. This results in an intrinsic value of A$51.64, which, compared to the current share price of A$77.42, we see that REA Group is quite expensive and not available at a discount at this time.
Next Steps:
Valuation is only one side of the coin in terms of building your investment thesis, and it 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 REA, I’ve compiled three pertinent aspects you should further research:
PS. Simply Wall St does a DCF calculation for every AU 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.