Today we are going to review a valuation method used to estimate the attractiveness of A2Z Infra Engineering Limited (NSE: A2ZINFRA) as an investment opportunity by estimating the company’s future cash flows. and discounting them to their present value. Our analysis will use the discounted cash flow (DCF) model. There really isn’t much to do, although it might seem quite complex.

There are many ways that businesses can be assessed, so we would like to point out that a DCF is not perfect for all situations. If you are interested in knowing more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St.

See our latest review for A2Z Infra Engineering

The model

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. To begin with, we need to get cash flow estimates for 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) = ₹ 1.0b

After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. 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 6.7%. We discount the terminal cash flows to their present value at a cost of equity of 19%.

Terminal value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = 275m × (1 + 6.7%) ÷ (19% – 6.7%) = ₹ 2.4b

Present value of terminal value (PVTV)= TV / (1 + r)^ten= ₹ 2.4b ÷ (1 + 19%)^ten= ₹ 408m

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is ₹ 1.4b. In the last step, we divide the equity value by the number of shares outstanding. From the current share price of 6.4, the company is shown at fair value at a 19% discount from the current share price. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.

Important assumptions

The above calculation is very dependent on two assumptions. One is the discount rate and the other is the cash flow. 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 consider A2Z Infra Engineering 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 debt into account. . In this calculation, we used 19%, which is based on a leveraged beta of 2,000. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average 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:

While a business valuation is important, it shouldn’t be the only metric you look at when researching a business. The DCF model is not a perfect stock assessment tool. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. For A2Z Infra Engineering, there are three additional items that you should consider further:

1. Risks: We think you should evaluate the 3 warning signs for A2Z Infra Engineering (1 doesn’t suit us too much!) We reported before investing in the company.
2. Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!
3. Other environmentally friendly companies: Are you concerned about the environment and think that consumers will buy more and more environmentally friendly products? Browse our interactive list of companies thinking about a greener future to discover stocks you might not have thought of!

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

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock 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 documents. Simply Wall St has no position in any of the stocks mentioned.