Using discounted cash flow (DCF) analysis what would you pay for this company's stock?
Company XYZ does $100 million in sales and has a 30% net profit margin. The company earns 20% Return on Equity and is growing at an average of 20% per year. It's expected to do so for another 10 years and then drop to a growth rate of 5%.
Assuming the company is in a mature industry with well defined value chains, competitors, etc. and the company is a leader in its space, what is the fair value of the company? According to the "Margin of Safety" concept in Value Investing, how much SHOULD you pay for this company's stock?
Remember, everybody will have a different answer - we're looking for the one that could make the best case for their answer. So be ready to defend it!
Answers
1130 points
sundarkambam answered 11 months ago …
Assuming $100 is the Value of one equity Share.
Then $20 is the EPS ( 20% return on Equity)
Using a discount rate of 11% , the earning in the first year is $24 and the present value at 11% is $21.62.
Similarly the earnings in the second year is 28.80 and the present value is 23.37. and so on.
Thus the earnings in the 10th year is 123.83 and its present value is 43.61.
Total of present value from year 1 to 10 is $314.84
From the 11th year onwards the earnings are expected to grow at 5%. Thus the earnings for 11th year is $130.03.
Total of present value of 130.03 from 11th year onwards at 5% growth rate with a 11% discounting comes to $ 763.24
So the Total Present value of the Stock comes to $314.84 + $ 763.24 = $ 1078.08
127 points
WilliamYoung answered 11 months ago …
Revenues are projected to rise from 100mil annual to 30.72bil annual in 10 years. Return on Equity is projected to rise from 20mil annual to 6.144bil in the same 10 years. Beginning in the 11th year, growth revenues would continue at 1.5bil+ annually and ROE 3.072bil+.
This company should be valued at approximately 1 and 1/2 total revenues using actual current numbers, i.e. 100mil revenue would evaluate it at approximately 150mil. It could also be valued at 4 to 5x net profit in this case 80mil to 100mil.
Projections are nice but the purchase of a company and its evaluation is based on today even though the future is of course considered (since no future no buy) as the major reason to buy.
1786 points
ChaosNantuko answered 11 months ago …
100 million in sales with a 30% profit margin is EPS of 30 million.
That will grow to an EPS of about 185.75 million by the end of the 10 year period. At that point in time, growth will slow down to just 5% a year. At a slow growth of just 5% annually, I'd guess it gets a P/E ratio of around 12. 12 times 185.75 million is 2.2 billion. So the companies value in 10 years will be about 2.2 billion. For me to buy a company, I require an expected return annually of at least 20%. That equates to a 10 year return of 519%. So The max i would pay is 355 million for this company to give me that 519% return over the next 10 years. Due to the impossibility of knowing for sure if they'll make what they're projected to, i'd need another 15% as a moat. So i'd be willing to pay 302 million.
1130 points
sundarkambam answered 11 months ago …
Another way of looking at this issue ......
Sales = $100 Million
Earnings ( Net Profit) = 30% of $100 Million = $30 Million
Return on Equity = 20%
Thus Total Equity = $30 Million divided by 20% = $150 Million
Thus Earnings Per Share ( Earnings divided by Total Equity ) = $ 0.20
Using a discount rate of 11% , the earning in the first year is $0.24 and the present value at 11% is $0.22.
Similarly the earnings in the second year is $0.29 and the present value is $0.24. and so on.
Thus the earnings in the 10th year is $1.24 and its present value is $0. 44.
Total of present value from year 1 to 10 is $3.14
From the 11th year onwards the earnings are expected to grow at 5%. Thus the earnings for 11th year is $1.30.
Total of present value of $1.30 from 11th year onwards at 5% growth rate with a 11% discounting comes to $ 7.63
So the Total Present value of the Stock per Share comes to $3.14 + $ 7.63 = $ 10.79
Now Multiply $10.79 with the number of Shares and Voila !!! you get the Value to be Paid for the total stock of the company.
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