Revolution Beauty Group plc intrinsic value estimate (LON: REVB)
Today we are going to review a valuation method used to estimate the attractiveness of Revolution Beauty Group plc (LON: REVB) as an investment opportunity by taking expected future cash flows and discounting them. at their current value. We will use the Discounted Cash Flow (DCF) model on this occasion. 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 draw your attention to the fact that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something of interest to you.
Discover our latest analysis for Revolution Beauty Group
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. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. 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.
Generally, we assume that a dollar today is worth more than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF (£, Million)||United Kingdom £ 3.00m||United Kingdom £ 10.5million||United Kingdom £ 14.0 million||United Kingdom £ 16.6 million||United Kingdom £ 18.8million||United Kingdom £ 20.6 million||United Kingdom £ 22.1 million||UK £ 23.2m||£ 24.1million in UK||United Kingdom £ 24.8million|
|Source of estimated growth rate||Analyst x1||Analyst x1||Analyst x1||Est @ 18.63%||Est @ 13.31%||Est @ 9.59%||Est @ 6.98%||Est @ 5.16%||Est @ 3.88%||Is @ 2.99%|
|Present value (£, million) discounted at 5.8%||£ 2.8||United Kingdom £ 9.4||United Kingdom £ 11.8||United Kingdom £ 13.3||United Kingdom £ 14.2||United Kingdom £ 14.7||United Kingdom £ 14.9||United Kingdom £ 14.8||United Kingdom £ 14.6||United Kingdom £ 14.2|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = £ 124 million in the UK
We now need to calculate the Terminal Value, which takes into account all future cash flows after this ten year period. 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 5.8%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = £ 25m in UK × (1 + 0.9%) ÷ (5.8% to 0.9%) = £ 516m in UK
Present value of terminal value (PVTV)= TV / (1 + r)ten= UK £ 516m ÷ (1 + 5.8%)ten= £ 295 million in the UK
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is £ 419million. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of UK £ 1.3, the company is shown at fair value at a discount of 5.4% 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.
We draw your attention to the fact 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 Revolution Beauty 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 5.8%, which is based on a leveraged beta of 0.993. 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.
While important, calculating DCF is just one of the many factors you need to assess for 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, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For Revolution Beauty Group, there are three fundamental factors you should research further:
- Risks: As an example, we have found 3 warning signs for Revolution Beauty Group (2 don’t sit too well with us!) Which you need to consider before investing here.
- Future benefits: How does REVB’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth expectations chart.
- 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!
PS. Simply Wall St updates its DCF calculation for every UK 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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