Today we are going to review a valuation method used to estimate the attractiveness of Bright Scholar Education Holdings Limited (NYSE: BEDU) as an investment opportunity by taking expected future cash flows and taking them into account. discounting to today’s value. This will be done using the Discounted Cash Flow (DCF) model. Don’t be put off by the lingo, the underlying calculations are actually pretty straightforward.

Remember, however, that there are many ways to estimate the value of a business, and a DCF is just one method. If you still have burning questions about this type of valuation, take a look at Simply Wall St.

Check out our latest analysis for Bright Scholar Education Holdings

Step by step in the calculation

We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually, the first stage is higher growth, and the second stage is a lower growth stage. 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) = CN ¥ 877m

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. For a number of reasons, a very conservative growth rate is used that cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 11%.

Terminal value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = CN ¥ 129m × (1 + 2.0%) ÷ (11% – 2.0%) = CN ¥ 1.5b

Present value of terminal value (PVTV)= TV / (1 + r)^ten= CN ¥ 1.5b ÷ (1 + 11%)^ten= CN ¥ 553m

Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is CN ¥ 1.4b. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of $ 1.9, the company appears to be around fair value at the time of writing. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.

Important assumptions

The above calculation is very dependent on two assumptions. One is the discount rate and the other is the cash flow. You don’t have to agree with these entries, I recommend that you redo the math yourself and play around with it. 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 Bright Scholar Education Holdings 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 the debt. In this calculation, we used 11%, which is based on a leveraged beta of 1.745. 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.

To move on :

While a business valuation is important, it shouldn’t be the only metric you look at when researching a business. It is not possible to achieve a rock-solid valuation with a DCF model. 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 Bright Scholar Education Holdings, we have put together three fundamental aspects that you should take a closer look at:

1. Risks: Take risks, for example – Bright Scholar Education Holdings has 4 warning signs (and 1 which is a bit obnoxious) we think you should know that.
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 picks from top analysts: Interested in seeing what analysts think? Take a look at our interactive list of analysts’ top stock picks to find out what they think might have a compelling outlook for the future!

PS. Simply Wall St updates its DCF calculation for every US stock every day, so if you want to find the intrinsic value of any other stock just search here.

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 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 documents. Simply Wall St has no position in the mentioned stocks.

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