Which Valuation Model Should You Listen To When Valuing Boliden AB’s (STO:BOL)?

With so many different financial models generating different conclusions, choosing the most relevant one to value a company can be daunting. A prime example of conflicts between valuation models is Boliden AB’s (STO:BOL). While my discounted cash flow (DCF) model tells me that it is overvalued by 9.34%, my relative valuation model says it is undervalued by 24.43%. So, which model is more reliable and why?

View our latest analysis for Boliden

Deep-dive into intrinsic valuation

At the heart of the DCF is the basic assumption that a firm’s intrinsic valuation is equivalent to the sum of all its future free cash flows (FCF). As those familiar with the DCF will know, forecasting FCFs reliably past 5 years is often a difficult and subjective task, which is why I’ve used analyst FCF forecasts as a starting point for my model. To obtain the per share intrinsic value of BOL, we must first discount the sum of BOL’s future FCFs by 13%, which gives us an equity value of SEKkr50.3b, then 273.51k shares outstanding are divided through. This results in an intrinsic value of SEK183.83. Check out the source of my intrinsic value here.,

But is this value reliable? A key assumption in DCFs is that by the final year of our forecast horizon, which is year 5 in BOL’s case, a company is assumed to be mature and therefore FCF should be growing at a sustainable rate. At -3.79%, final year FCF growth is unsustainably low. If this assumption held true, BOL would shrink to a point where it would cease to exist very soon, which is a highly unlikely outcome. To improve our DCF analysis, we could extend the terminal year until FCF growth moderates to a more sustainable level around 1% to 5%. But investors also have to be mindful that there are far less data points the further out we go.

A closer look at relative valuation

Unlike the DCF model, relative valuation is based on a different principle and therefore, has its own set of issues. The underlying assumption is that two companies with the same risk-return profiles should be priced identically. The hardest part; however, is finding companies that are similar to BOL. As such, I’ve used the Metals and Mining industry as a proxy for BOL. To calculate the “true” value of BOL, we multiply BOL’s earnings by the industry’s P/E ratio to obtain a share price of SEK250.1, which means BOL is undervalued. But is this a dependable conclusion?

One quick way of finding out is to see if BOL shares a similar growth profile to the overall Metals and Mining industry we are comparing it to. At -17.71% earnings growth next year, BOL has a dramatically different earnings growth profile to the overall Metals and Mining industry, which is expected to grow at -0.14%. Unfortunately, this check shows that the Metals and Mining industry is a poor proxy for BOL, which weakens our relative valuation analysis. Alternatively, manually selecting companies that shared similar growth profiles with BOL could vastly improve our analysis. I’d encourage you to do this by taking a look at BOL’s competitors.

Which Model Is Superior?

Both are somewhat weakened by assumptions we have used to fill in the gaps. While intrinsic valuation is immune from market irrationality and mispricing, it is highly exposed to forecasting error. On the other hand, relative valuation is easy to calculate but affected by overall market mispricing. For example, relative valuation would not have been an effective tool to value a technology company at the height of the dotcom bubble in 2000. Given the pros and cons that I have laid out, I encourage you to derive a valuation by calculating a weighted average share price by using both models.

Next Steps:

For BOL, I’ve compiled three fundamental aspects you should look at:

1. Financial Health: Does BOL 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.

2. Future Earnings: How does BOL’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: Are there other high quality stocks you could be holding instead of BOL? 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 STO 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.