Today we will walk through one way to estimate the intrinsic value of Shenzhen International Holdings Limited (HKG:152) by taking expected future cash flows and discounting them to the present value. On this occasion, we will use the Discounted Cash Flow (DCF) model. There really isn’t much to do, although it may seem quite complex.
We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.
Check out our latest analysis for Shenzhen International Holdings
Is Shenzhen International Holdings Fairly Valued?
As Shenzhen International Holdings operates in the infrastructure sector, we have to calculate intrinsic value slightly differently. Instead of using free cash flow, which is difficult to estimate and often not reported by industry analysts, dividend payments per share (DPS) are used. This often underestimates the value of a stock, but it can still be a good comparison against competitors. The “Gordon Growth Model” is used, which simply assumes that dividend payments will continue to increase at a sustainable rate of growth forever. For a number of reasons, a very conservative growth rate is used that cannot exceed that of a company’s Gross Domestic Product (GDP). In this case, we used the 5-year average of the 10-year government bond yield (1.5%). The expected dividend per share is then discounted to its present value at a cost of equity of 7.5%. Compared to the current share price of HK$7.4, the company looks quite undervalued at a 39% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
Value per share = Expected dividend per share / (Discount rate – Perpetual growth rate)
= HK$0.7 / (7.5% – 1.5%)
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. You don’t have to agree with these entries, I recommend you redo the calculations yourself and play around with them. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Shenzhen International 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 takes debt into account. In this calculation, we used 7.5%, which is based on a leveraged beta of 1.241. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Let’s move on :
While valuing a business is important, it ideally won’t be the only piece of analysis you look at for a business. DCF models are not the be-all and end-all of investment valuation. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. Why is intrinsic value higher than the current stock price? For Shenzhen International Holdings, there are three additional things you should explore:
- Risks: You should be aware of the 4 warning signs for Shenzhen International Holdings (1 should not be ignored!) that we discovered before considering an investment in the company.
- Future earnings: How does 152’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
PS. Simply Wall St updates its DCF calculation for every Hong Kong stock daily, so if you want to find the intrinsic value of any other stock, just search here.
Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.