Key Insights
- The projected fair value for Chengdu M&S Electronics TechnologyLtd is CN¥17.64 based on Dividend Discount Model
- Current share price of CN¥23.70 suggests Chengdu M&S Electronics TechnologyLtd is potentially 34% overvalued
- Industry average of 494% suggests Chengdu M&S Electronics TechnologyLtd's peers are currently trading at a higher premium to fair value
Today we will run through one way of estimating the intrinsic value of Chengdu M&S Electronics Technology Co.,Ltd. (SHSE:688311) by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
The Method
We have to calculate the value of Chengdu M&S Electronics TechnologyLtd slightly differently to other stocks because it is a aerospace & defense company. In this approach dividends per share (DPS) are used, as free cash flow is difficult to estimate and often not reported by analysts. This often underestimates the value of a stock, but it can still be good as a comparison to competitors. We use the Gordon Growth Model, which assumes dividend will grow into perpetuity at a rate that can be sustained. The dividend is expected to grow at an annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.9%. We then discount this figure to today's value at a cost of equity of 7.6%. Relative to the current share price of CN¥23.7, the company appears reasonably expensive at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
Value Per Share = Expected Dividend Per Share / (Discount Rate - Perpetual Growth Rate)
= CN¥0.8 / (7.6% – 2.9%)
= CN¥17.6
The Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Chengdu M&S Electronics TechnologyLtd 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 accounts for debt. In this calculation we've used 7.6%, which is based on a levered beta of 0.825. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
SWOT Analysis for Chengdu M&S Electronics TechnologyLtd
- Cash in surplus of total debt.
- Balance sheet summary for 688311.
- No major weaknesses identified for 688311.
- Expected to breakeven next year.
- Has sufficient cash runway for more than 3 years based on current free cash flows.
- Good value based on P/S ratio compared to estimated Fair P/S ratio.
- Debt is not well covered by operating cash flow.
- Is 688311 well equipped to handle threats?
Looking Ahead:
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value lower than the current share price? For Chengdu M&S Electronics TechnologyLtd, we've put together three fundamental elements you should explore:
- Risks: You should be aware of the 1 warning sign for Chengdu M&S Electronics TechnologyLtd we've uncovered before considering an investment in the company.
- Future Earnings: How does 688311's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years 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 is out there you may be missing!
PS. Simply Wall St updates its DCF calculation for every Chinese stock every day, so if you want to find the intrinsic value of any other stock just search here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an 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 account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.