A Look At The Intrinsic Value Of FDM Group (Holdings) plc (LON:FDM)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, FDM Group (Holdings) fair value estimate is UK£3.23

• FDM Group (Holdings)'s UK£3.34 share price indicates it is trading at similar levels as its fair value estimate

• Analyst price target for FDM is UK£4.44, which is 37% above our fair value estimate

Does the April share price for FDM Group (Holdings) plc (LON:FDM) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for FDM Group (Holdings)

Step By Step Through The Calculation

We're using 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 a stable growth rate. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (£, Millions)	UK£26.2m	UK£27.0m	UK£30.2m	UK£26.7m	UK£24.7m	UK£23.5m	UK£22.8m	UK£22.5m	UK£22.3m	UK£22.3m
Growth Rate Estimate Source	Analyst x2	Analyst x2	Analyst x2	Est @ -11.52%	Est @ -7.57%	Est @ -4.81%	Est @ -2.87%	Est @ -1.52%	Est @ -0.57%	Est @ 0.09%
Present Value (£, Millions) Discounted @ 7.7%	UK£24.3	UK£23.3	UK£24.2	UK£19.9	UK£17.0	UK£15.1	UK£13.6	UK£12.4	UK£11.5	UK£10.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£172m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.6%. We discount the terminal cash flows to today's value at a cost of equity of 7.7%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£22m× (1 + 1.6%) ÷ (7.7%– 1.6%) = UK£377m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£377m÷ ( 1 + 7.7%)¹⁰= UK£180m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is UK£352m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of UK£3.3, 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.

dcf

Important Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 FDM Group (Holdings) 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 7.7%, which is based on a levered beta of 1.099. 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 FDM Group (Holdings)

Strength

• Earnings growth over the past year exceeded the industry.

• Currently debt free.

• Dividend is in the top 25% of dividend payers in the market.

Weakness

• No major weaknesses identified for FDM.

Opportunity

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

Threat

• Dividends are not covered by earnings.

• Annual earnings are forecast to decline for the next 3 years.

Looking Ahead:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For FDM Group (Holdings), we've compiled three further factors you should further examine:

1. Risks: To that end, you should learn about the 2 warning signs we've spotted with FDM Group (Holdings) (including 1 which is significant) .

2. Future Earnings: How does FDM'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: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St updates its DCF calculation for every British stock every day, so if you want to find the intrinsic value of any other stock 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.