Does the March share price for Ta Chen Stainless Pipe Co., Ltd. (TPE: 2027) reflect what it is really worth? Today we’re going to estimate the intrinsic value of the stock by projecting its future cash flows and then discounting it to today’s value. One way to achieve this is to use the DCF (Discounted Cash Flow) model. Don’t let the jargon put you off, the math behind it is actually pretty simple.
We generally believe that a company’s value is the present value of all the cash it will generate in the future. However, a DCF is just one rating metric among many and not without its flaws. For those familiar with stock analysis, the Simply Wall St analytical model might be of interest here.
Check out our latest analysis for Ta Chen Stainless Pipe
Step by step through the calculation
We use the two-tier growth model, which simply means that we consider two phases in the company’s growth. In the initial phase, the company can have a higher growth rate, and for the second phase a stable growth rate is usually assumed. First, we need to get estimates of the next ten years of cash flow. We use analyst estimates whenever possible. However, if these are not available, we extrapolate the previous free cash flow (FCF) from the most recent estimate or reported value. We assume that companies with shrinking free cash flow will slow their rate of contraction and that companies with increasing free cash flow will slow their growth rate over this period. We do this to reflect that growth tends to slow down more in the first few years than in later years.
In general, we assume that a dollar today is more valuable than a dollar in the future. Hence, we need to discount the sum of these future cash flows to get a present value estimate:
10-year free cash flow (FCF) estimate
| 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
| Leverage FCF (NT $, Millions) | -NT $ 6.35b | NT $ 4.65b | NT $ 6.56b | NT $ 8.46b | NT $ 10.2b | NT $ 11.7b | NT $ 12.9b | NT $ 13.9b | NT $ 14.7b | NT $ 15.3b |
| Source for growth rate estimation | Analyst x2 | Analyst x1 | Est @ 41.1% | Est @ 29.02% | Est @ 20.56% | Est @ 14.64% | Est @ 10.5% | East at 7.6% | Est @ 5.57% | Est @ 4.15% |
| Present Value (NT $, Millions) Discount of 13% | -NT $ 5.6k | NT $ 3.7k | NT $ 4.6k | NT $ 5.3k | NT $ 5.6k | NT $ 5.7k | NT $ 5.6k | NT $ 5.4k | NT $ 5.0k | NT $ 4.6k |
(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = NT $ 40b
The second level is also known as Terminal Value. This is the company’s cash flow after the first stage. The Gordon growth formula is used to calculate the terminal value using a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 0.8%. We discount the terminal cash flows to today’s value at a cost of equity of 13%.
Terminal value (TV)= FCF2030 × (1 + g) ÷ (r – g) = NT $ 15b × (1 + 0.8%) ÷ (13% – 0.8%) = NT $ 130b
Present value of the terminal value (PVTV)= TV / (1 + r) 10 = NT $ 130b ÷ (1 + 13%) 10 = NT $ 40b
The total or equity value is then the sum of the present value of future cash flows, which in this case is NT $ 80 billion. The final step is to divide the equity value by the number of shares issued. Compared to its current share price of NT $ 29.4, the company appears to have reasonably good value at a 41% discount to the current share price. Ratings, however, are inaccurate instruments, more like a telescope – move a few degrees and land in a different galaxy. Keep that in mind.
TSEC: 2027 Discounted Cash Flow March 22, 2021
TSEC: 2027 Discounted Cash Flow March 22, 2021 The assumptions
The most important inputs for a discounted cash flow are now the discount rate and of course the actual cash flows. If you do not agree with this result, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclical nature of an industry or the future capital requirements of a company, so it does not give a complete picture of a company’s potential performance. Given that we view Ta Chen Stainless Pipe as a potential shareholder, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) that makes up debt. We used 13% in this calculation based on a leverage beta of 1.929. Beta is a measure of the volatility of a stock compared to the overall market. We get our beta from the industry average beta of comparable companies around the world with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Go on:
Assessment is only one side of the coin in creating your investment thesis and ideally not the only analysis you consider for a company. A foolproof valuation is not possible with a DCF model. Instead, the best use for a DCF model is to test certain assumptions and theories to determine whether they would result in the company becoming undervalued or overvalued. If a company is growing at a different rate, or if the cost of equity or the risk-free rate changes dramatically, performance can look very different. Why is the intrinsic value higher than the current share price? For Ta Chen Stainless Pipe, there are three key elements that you should investigate further:
- Risks: Every company has it and we discovered it 3 warning signs for Ta Chen Stainless Pipe (1 of which is significant!) that you should know about.
- Future earnings: What is the growth rate of 2027 compared to its competitors and the broader market? Learn more about analyst consensus number for the years to come by interacting with our free analyst growth expectation chart.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else you might be missing!
PS. The Simply Wall St app performs a discounted cash flow assessment for every share on the TSEC every day. If you want to find the calculation for other stocks, just search here.
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This article from Simply Wall St is of a general nature. It is not a recommendation to buy or sell stocks and does not take into account your goals or your financial situation. We want to provide you with a long-term, focused analysis based on fundamental data. Note that our analysis may not take into account the latest price sensitive company announcements or quality materials. Simply Wall St has no position in the stocks mentioned.
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