Home Discount rate IRICO Group New Energy Company Limited Embedded Value Estimate (HKG: 438)

IRICO Group New Energy Company Limited Embedded Value Estimate (HKG: 438)

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In this article, we will estimate the intrinsic value of IRICO Group New Energy Company Limited (HKG: 438) by taking expected future cash flows and discounting them to their present value. To this end, we will take advantage of the Discounted Cash Flow (DCF) model. It may sound complicated, but it’s actually quite simple!

There are many ways businesses can be assessed, so we would like to point out that a DCF is not perfect for all situations. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something of interest to you.

See our latest analysis for IRICO Group New Energy

What is the estimated valuation?

We have to calculate the value of IRICO Group New Energy in a slightly different way from other stocks because it is an electronics company. In this approach, dividends per share (DPS) are used because 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 a good comparison to the competition. We use Gordon’s growth model, which assumes that the dividend will grow in perpetuity at a rate that can be sustained. For a number of reasons, a very conservative growth rate is used that cannot exceed that of a company’s gross domestic product (GDP). In this case, we used the 5-year average of the 10-year government bond yield (1.5%). The expected dividend per share is then discounted to the present value at a cost of equity of 8.0%. Compared to the current share price of HK $ 20.0, the company appears to be around fair value at the time of writing. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.

Value per share = Expected dividend per share / (Discount rate – Perpetual growth rate)

= CN ¥ 1.1 / (8.0% – 1.5%)

= HK $ 19.7

SEHK: 438 Discounted Cash Flow November 7, 2021

The hypotheses

The above calculation is very dependent on two assumptions. One is the discount rate and the other is 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 complete picture of a company’s potential performance. Since we consider IRICO Group New Energy 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 8.0%, which is based on a leveraged beta of 1.315. 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 from globally comparable companies, with a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.

Looking forward:

While a business valuation is important, ideally, it won’t be the only analysis you look at for a business. The DCF model is not a perfect equity valuation tool. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. For IRICO Group New Energy, there are three essential factors that you should consider further:

  1. Risks: You should be aware of the 3 warning signs for IRICO Group New Energy (2 are a little worrisome!) That we discovered before considering an investment in the company.
  2. Future benefits: How does 438’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.
  3. 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. The Simply Wall St app performs a daily discounted cash flow assessment for each SEHK share. If you want to find the calculation for other actions, 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 any of the stocks mentioned.

Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.


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