Yahoo Finance Softcat plc (LON:SCT) Investors Are Paying Above The Intrinsic Value
How far off is Softcat plc (LON:SCT) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today’s value. I will use the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. Please also note that this article was written in November 2018 so be sure check out the updated calculation by following the link below.
Check out our latest analysis for Softcat
Crunching the numbers
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.
5-year cash flow estimate
2019 | 2020 | 2021 | 2022 | 2023 | |
Levered FCF (£, Millions) | £52.18 | £60.20 | £64.90 | £67.30 | £78.07 |
Source | Analyst x4 | Analyst x4 | Analyst x3 | Analyst x1 | Est @ 16%, capped from 17.63% |
Present Value Discounted @ 8.28% | £48.19 | £51.35 | £51.12 | £48.96 | £52.45 |
Present Value of 5-year Cash Flow (PVCF)= UK£252m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 1.4%. We discount this to today’s value at a cost of equity of 8.3%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = UK£78m × (1 + 1.4%) ÷ (8.3% – 1.4%) = UK£1.2b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = UK£1.2b ÷ ( 1 + 8.3%)5 = UK£773m
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is UK£1.0b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of £5.2. Compared to the current share price of £6.45, the stock is fair value, maybe slightly overvalued and not available at a discount at this time.
The assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Softcat as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 8.3%, which is based on a levered beta of 0.800. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
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 SCT, I’ve put together three relevant aspects you should further examine:
Financial Health: Does SCT 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 SCT’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 SCT? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. The Simply Wall St app conducts a discounted cash flow for every stock on the LON every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see past 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. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
