A look at the intrinsic value of Pegatron Corporation (TWSE:4938)

Key findings

• Using the 2-step free cash flow to equity, the estimated fair value of Pegatron is NT$97.53
• Pegatron’s share price of NT$106 suggests that the price is at a similar level to the estimated fair value.
• The analyst price target of NT$101 for 4938 is 3.5% above our fair value estimate

How far is Pegatron Corporation (TWSE:4938) 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. This is done using the Discounted Cash Flow (DCF) model. Before you think you can’t understand it, just keep reading! It’s actually a lot less complex than you think.

However, keep in mind that there are many ways to estimate the value of a company, and a DCF is just one of them. If you still have pressing questions about this type of valuation, take a look at Simply Wall St’s analysis model.

Check out our latest analysis for Pegatron

What is the estimated value?

We use what is called a 2-stage model, which simply means that we have two different growth periods for the company’s cash flows. Generally speaking, the first stage is one of higher growth, and the second stage is one of lower growth. First, we need to get estimates for the next ten years of cash flows. Where possible, we use analyst estimates, but when these aren’t available, we extrapolate the previous free cash flow (FCF) from the last estimate or 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 take into account that growth tends to slow more in the early years than in later years.

In general, we assume that a dollar today is worth more than a dollar in the future. Therefore, we discount the value of these future cash flows to their estimated value in today’s dollars:

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) = NT$129 billion

After calculating the present value of future cash flows in the first 10-year period, we need to calculate the terminal value, which takes into account all future cash flows after the first period. For various reasons, a very conservative growth rate is used, which cannot exceed a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (1.0%) 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 8.2%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = NT$21 billion × (1 + 1.0%) ÷ (8.2% – 1.0%) = NT$288 billion

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= NT$288 billion ÷ ( 1 + 8.2 %)¹⁰= NT$131 billion

The total value or equity value is then the sum of the present value of future cash flows, which in this case is NT$260 billion. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of NT$106, the company appears to be about its fair value at the time of writing. However, valuations are imprecise instruments, much like a telescope – move a few degrees and you end up in another galaxy. Keep that in mind.

The assumptions

We would like to point out that 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 does not take into account the possible 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 consider Pegatron as potential shareholders, the cost of equity is used as the discount rate and not the cost of capital (or weighted average cost of capital, WACC) which takes debt into account. In this calculation, we used 8.2%, which is based on a leveraged beta of 1.322. 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 an imposed limit of between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT analysis for Pegatron

Go on:

Valuation is only one side of the coin when developing your investment thesis and should not be the only metric you consider when researching a company. The DCF model is not a perfect tool for stock valuation. Instead, a DCF model is best used to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. If a company grows differently or its cost of equity or risk-free rate changes significantly, the outcome could be very different. For Pegatron, we’ve compiled three important factors you should examine in more detail:

1. Risks: For example, we found 1 warning sign for Pegatron that you should know.
2. Future income: How does 4938’s growth rate compare to its competitors and the overall market? Learn more about analyst consensus numbers for the coming years by using our free chart of analyst growth expectations.
3. 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 you might be missing out on!

PS. The Simply Wall St app runs a discounted cash flow valuation for every stock on the TWSE 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 the basis of 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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