In this article I am going to calculate the intrinsic value of NagaCorp Ltd (SEHK:3918) using the discounted cash flows (DCF) model. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this after January 2018 then I highly recommend you check out the latest calculation for NagaCorp here.

Crunching the numbers

I’ve used the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have perpetual stable growth rate. To begin, I pulled together the analyst consensus forecast of 3918’s levered free cash flow (FCF) over the next five years and discounted these figures at the rate of 13.71%. 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 $1,283.9M. Keen to understand how I calculated this value? Take a look at our detailed analysis here.

The infographic above illustrates how 3918’s earnings are expected to move in the future, which should give you an idea of 3918’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. The present value of the terminal value after discounting it back five years is $2,349.9M.

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 $3,633.8M. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value of HK$6.54, which, compared to the current share price of HK$6.45, we see that NagaCorp is about right, perhaps slightly undervalued at a 1.44% discount to what it is available for right now.

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.

For 3918, there are three important factors you should further examine:

• 1. Financial Health: Does 3918 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.

• 2. Future Earnings: How does 3918’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.

• 2. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of 3918? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!