I am going to run you through how I calculated the intrinsic value of Reliance Communications Limited (NSEI:RCOM) 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 March 2018 then I highly recommend you check out the latest calculation for Reliance Communications here.

What’s the value?

We are going to use a two-stage DCF 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 RCOM’s levered free cash flow (FCF) over the next five years and discounted these figures at the cost of equity of 23%. 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 ₹76.31B. Want to understand how I calculated this value? Read our detailed analysis here.

The infographic above illustrates how RCOM’s top and bottom lines are expected to move in the future, which should give you an idea of RCOM’s outlook. Then, I determine the terminal value, which accounts for all the future cash flows after the five years. I’ve decided 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. After discounting the terminal value back five years, the present value becomes ₹64.60B.

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is ₹140.91B. The last step is to then divide the equity value by the number of shares outstanding. This results in an intrinsic value of ₹50.95, which, compared to the current share price of ₹27.9, we find that Reliance Communications is quite undervalued at a 45.24% discount to what it is available for right now.

Next Steps:

Although the valuation of a company is important, 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 RCOM, I’ve put together three pertinent aspects you should further research:

1. Financial Health: Does RCOM 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 RCOM’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 High Quality Alternatives: Are there other high quality stocks you could be holding instead of RCOM? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!