– Share price
In order to come up with the Enterprise Value, we combine the present value of future free cash flow (from Year 6 to 10) with the current value of the terminal value. Then, subtracting any existing debt and adding the current cash gives equity holders their free cash flow.
The liabilities and assets on the balance sheet are the source of today’s debt and cash value.
And, here you go –
This price of Rs.300 is significant. What does it suggest?
The end result of the valuation process is a value of Rs. 300. Our assumptions were sound, allowing us to be confident in this number. Now you can use it to judge the stock’s market value on the exchanges and decide whether or not to act. For instance, if it is trading at Rs.425, then you know that it is overpriced in comparison to its fair worth, meaning it may be wise to hold off for now.
If the stock is trading at Rs.225, it is considered undervalued and can be a good investment option. On the other hand, if the stock is being traded at Rs.300, then it can be said that it has been fairly valued.
The model we have constructed is linked; any alteration to any figure within this model will have an effect on the stock price.
For instance, the assumption sheet will see the material consumed as a percentage of sales for Year 6 changing to 60%, resulting in the share price being revised to Rs.462 up from Rs.300.
I advise you to modify the terminal growth rate to 4.5%, which will result in a different share price, namely Rs.323. This model’s flexibility enables you to view the effects of small alterations and create accurate results. All tables and values are interlinked, so any disparity across them will be reflected in the final figure.
When you feel these alterations are called for, it brings me to the next thought.
Developing a financial model is relatively simple. With experience, one can construct a satisfactory model within a few days. Yet the key element is maintaining its accuracy; follow the company closely, staying abreast of managements interviews and announcements. Whenever fresh data becomes available, update the model accordingly.
For instance, when announcing quarterly results, the company may indicate a decrease in their CAPEX expenditure. In response to this, adjust your model accordingly and take into account the resulting share price fluctuation or re-rating. Additionally, it is important to maintain a separate sheet within your workbook, which explains why these changes were made – acting as your notes for future reference.
To close this chapter and module, I’d like to emphasize that the share price of Rs.300 is only a calculated outcome of our model. Since models can be inaccurate sometimes, we should consider a 10% margin of error. That means I will regard the fair value of the stock as anywhere between Rs.270 to Rs.330.
I am willing to buy the stock anywhere within this range, however having the safety net of a lower price is preferable.