Fair value calculation of Korvest Ltd (ASX:KOV)

Key findings

• Using the dividend discount model, Korvest’s fair value is AU$10.97

• With a share price of AU$8.89, Korvest appears to be trading close to its estimated fair value

How far is Korvest Ltd (ASX:KOV) from its intrinsic value? Using the most recent financial data, we will check whether the stock is fairly valued by estimating the company’s future cash flows and discounting them to their current value. We do this using the Discounted Cash Flow (DCF) model. Models like these may seem incomprehensible to a layperson, but they are relatively easy to follow.

Companies can be valued in many ways, so we want to point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, you can read the basics of this calculation in detail in Simply Wall St’s analysis model.

Check out our latest analysis for Korvest

Is Korvest fairly valued?

We need to calculate Korvest’s value a little differently than other stocks because it’s an engineering company. Rather than using free cash flows, which are difficult to estimate and often unreported by analysts in this industry, we use dividend payments per share (DPS). Unless a company pays out the majority of its free cash flow as dividends, this method will typically underestimate the stock’s value. We use the Gordon Growth Model, which assumes the dividend will grow at a sustainable rate over time. The dividend is expected to grow at an annual growth rate equal to the 5-year average 10-year Treasury yield of 2.3%. We then discount this figure to today’s value at a cost of equity of 7.7%. Compared to the current share price of AU$8.9, the company appears to be about fairly valued at a 19% discount to the current share price. However, ratings are imprecise instruments, much like a telescope – move a few degrees and you end up in a different galaxy. Keep this in mind.

The story goes on

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

= 0.6AU$ / (7.7% – 2.3%)

= 11.0 A$

The assumptions

The main inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with these inputs, I recommend repeating the calculations yourself and playing around with them. The DCF also doesn’t take into account the possible cyclicality of an industry or a company’s future capital needs and therefore doesn’t provide a complete picture of a company’s potential performance. Since we consider Korvest 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 debt into account. In this calculation, we used 7.7%, which is based on a leveraged beta of 1.189. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies with a set limit between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT analysis for Korvest

Strength

weakness

Opportunity

Danger

Looking ahead:

Valuation is only one side of the coin when building your investment thesis and just one of many factors you need to evaluate a company. It is not possible to get a foolproof valuation using a DCF model. Rather, it should be viewed as a guide to “what assumptions need to hold for this stock to be under/overvalued.” For example, changes in the company’s cost of equity or risk-free interest rate can significantly affect the valuation. For Korvest, we have compiled three additional points for you to consider:

1. Risks: Take risks, for example – Korvest has 2 warning signs In our opinion, you should be aware of this.

2. Other solid companies: Low debt, high returns on equity, and good past performance are the foundation of a strong company. Check out our interactive list of stocks with solid business fundamentals to see if there are any other companies you may not have considered!

3. More top analyst tips: Want to know what the analysts think? Take a look at our interactive list of analyst recommended stocks and find out which stocks they think could have attractive future prospects!

PS The Simply Wall St app does a discounted cash flow valuation for every stock on the ASX every day. If you want to find the calculation for other stocks, just search here.

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This Simply Wall St article is of a general nature. We comment solely on historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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