In this article, we’ll estimate the intrinsic value of The Property Franchise Group PLC (LON: TPFG) by taking expected future cash flows and discounting them to today’s value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won’t be able to figure it out, read on! It’s actually a lot less complex than you might imagine.

We generally think of a business’s value as the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. If you want to know more about discounted cash flows, the rationale for this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for Property Franchise Group

The method

We use the 2-step growth model, which simply means that we take into account two stages of business growth. During the initial period, the business can have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first step, we need to estimate the cash flow of the business over the next ten years. Since no free cash flow analyst estimate is available, we have extrapolated the previous free cash flow (FCF) from the last reported value of the company. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we discount the value of those future cash flows to their estimated value in today’s dollars. hui:

10-year Free Cash Flow (FCF) estimate

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = UK £ 46m

The second stage is also known as terminal value, this is the cash flow of the business after the first stage. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 0.9%. We discount the terminal cash flows to their present value at a cost of equity of 6.5%.

Terminal value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = UK £ 7.1m × (1 + 0.9%) ÷ (6.5% –0.9%) = UK £ 129m

Present value of terminal value (PVTV)= TV / (1 + r)^ten= UK £ 129m ÷ (1 + 6.5%)^ten= £ 69 million in the UK

The total value is the sum of the cash flows for the next ten years plus the final present value, which gives the total value of equity, which in this case is £ 115million. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of UK £ 2.9, the company appears to be roughly at fair value with a 20% discount to the current share price. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.

Important assumptions

We would like to stress that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we view Property Franchise Group 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 into account debt. . In this calculation, we used 6.5%, which is based on a leveraged beta of 1.052. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Looking forward:

Valuation is only one side of the coin in terms of building your investment thesis, and ideally, it won’t be the only piece of analysis you look at for a business. DCF models are not the alpha and omega of investment valuation. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. For Property Franchise Group, we’ve put together three relevant things you should consider:

1. Risks: Every company has them, and we have spotted 3 warning signs for Property Franchise Group you should know.
2. Management: Have insiders increased their shares to take advantage of market sentiment about TPFG’s future prospects? Check out our management and board analysis with information on CEO compensation and governance factors.
3. Other strong companies: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app performs a daily discounted cash flow assessment for each AIM share. If you want to find the calculation for other actions, do a search here.

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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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