A look at the intrinsic value of WirelessGate, Inc. (TSE:9419)

Key findings

• Using the 2-step free cash flow to equity, the estimated fair value of WirelessGate is JP¥293.
• WirelessGate’s share price of JP¥264 suggests that the price is at a similar level to the estimated fair value.

How far is WirelessGate, Inc. (TSE:9419) from its intrinsic value? Using the most recent financial data, we will check if the stock is fairly valued by taking the expected future cash flows and discounting them to their present value. To do this, we will use the Discounted Cash Flow (DCF) model. There is actually not too much involved in it, even though it may seem quite complex.

We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without its flaws. 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 WirelessGate

The model

We will use a two-stage DCF model which, as the name suggests, considers two phases of growth. The first stage is generally a higher growth phase that stabilizes toward the terminal value captured in the second “steady growth” stage. First, we need to estimate the next ten years of cash flows. Since we don’t have analyst estimates of free cash flow available, we extrapolated the previous free cash flow (FCF) from the company’s last reported value. We assume that companies with shrinking free cash flow will slow their rate of shrinkage and that companies with growing free cash flow will slow their growth rate over this period. We do this to account for the fact that growth tends to slow more in the early years than in later years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today. Therefore, the sum of these future cash flows is discounted to today’s value:

Estimation of free cash flow (FCF) over 10 years

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 1.2 billion JPY

We now need to calculate the terminal value that takes into account all future cash flows after this ten-year period. For various reasons, a very conservative growth rate is used that cannot exceed a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (0.2%) to estimate future growth. In the same way as with the 10-year “growth” period, we discount future cash flows to today’s value, using a cost of equity of 4.7%.

Final value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = JP¥142m × (1 + 0.2%) ÷ (4.7% – 0.2%) = JP¥3.2b

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 3.2 billion JP¥ ÷ (1 + 4.7%)¹⁰= 2.0 billion JPY

Total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total equity value, which in this case is JP¥3.2 billion. The final step is to divide the equity value by the number of shares outstanding. Relative to the current share price of JP¥264, the company appears to be roughly fairly valued at a 9.9% discount to the current share price. However, valuations are imprecise instruments, much like a telescope – move a few degrees and you end up in another galaxy. Keep this in mind.

The assumptions

We should point out that the key inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is making your own assessment of a company’s future performance, so try the calculation yourself and check your own assumptions. DCF also does not take into account the potential cyclicality of an industry or a company’s future capital needs, and therefore does not provide a complete picture of a company’s potential performance. Since we are viewing WirelessGate 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 4.7%, which is based on a leveraged beta of 0.800. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of global peers, with a set limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Next Steps:

Valuation is only one side of the coin when building your investment thesis and just one of many factors you need to evaluate for a company. The DCF model is not a perfect stock valuation tool. It should be viewed more as a guide to “what assumptions need to hold for this stock to be under/overvalued.” For example, making a small adjustment to the terminal value growth rate can dramatically change the overall result. For WirelessGate, we have compiled three other points you should evaluate:

1. Risks: For example, we found 5 warning signs for WirelessGate (2 cannot be ignored!) that you should know before investing here.
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. Other environmentally friendly companies: Are you concerned about the environment and believe that consumers will increasingly buy environmentally friendly products? Browse through our interactive list of companies thinking about a greener future and discover some stocks you may not have thought of yet!

PS The Simply Wall St app runs a discounted cash flow valuation for every stock on the TSE 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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