Yahoo Finance Modelling Halma plc’s (LON:HLMA) True Value
Choosing the right financial tool to evaluate a company can be a daunting task, especially when different models are giving you drastically different conclusions. A prime example of conflicts between valuation models is Halma plc’s (LSE:HLMA). While my discounted cash flow (DCF) model tells me that it is undervalued by 77.31%, my relative valuation model says it is overvalued by 63.29%. So, which model is more reliable and why?
Check out our latest analysis for Halma
Examining intrinsic valuation
The DCF model follows the principle that a firm’s “true” value today is equal to the sum of all its the future free cash flows (FCF) it will make in the future (to infinity). Since the hardest part of constructing a DCF is forecasting this, I’ve decided to use the average expected FCF forecasted by broker analysts in my model. Calculating the per share intrinsic value of HLMA involves two key steps. First, I discount the sum of HLMA’s future FCFs at 8.28%, which gives us an equity value of £2.97B. To get a per share intrinsic value for HLMA, I have to divide this by 379.13M shares outstanding, which gives me £7.82. This implies that broker analysts believe that HLMA is overvalued at £13.87. Take a look at how I arrived at this intrinsic value here.,
Before we move on, let’s evaluate whether this number is accurate. Since it is generally impossible to forecast FCFs indefinitely, it is common for analysts to forecast for an explicit forecast horizon and then assume the company is mature by the end of that period and in a stable growth phase. Given HLMA’s final year growth is at a sustainable 2.41%, we can rest assured that the assumptions we have made regarding an appropriate forecast horizon for HLMA are reasonable, and therefore our conclusions are significantly more dependable.
Deep-dive into relative valuation
While DCF models sum up future FCFs, relative valuation models are based on the idea that investors should pay the same price for two companies with identical risk and return profiles. Since the biggest dilemma is finding companies that are similar to HLMA, a viable proxy would be the overall Electronic industry itself. The calculations for relative valuation are quite simple. By multiplying HLMA’s earnings by the industry’s P/E ratio, we can obtain HLMA’s fair value of £5.09, which tells us that it is overvalued. However, should we believe this result?
One quick way of finding out is to see if HLMA shares a similar growth profile to the overall Electronic industry we are comparing it to. With a projected earnings growth rate of 9.31% for next year, HLMA has a similar growth profile when compared with the Electronic industry, which is projected to grow at 14.06%. This demonstrates that the Electronic industry is a good proxy for HLMA and ideal for our relative valuation.
Which Model Should I Care About?
Unfortunately, both models have their own merits and deficiencies, which means the truth lies somewhere in the middle. Relative valuation is straightforward but prone to overall market mispricing. Meanwhile, intrinsic valuation is independent from market tendencies; however, is highly exposed to human error. Ultimately, investors should derive their final valuation based off both models. I encourage you to weight each model depending on your preferences to calculate a weighted average target price.
Next Steps:
For HLMA, I’ve put together three important factors you should further examine:
Financial Health: Does HLMA 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.
Future Earnings: How does HLMA’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.
Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of HLMA? 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 does a DCF calculation for every GB stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
