Fair value calculation of Eternity Investment Limited (HKG:764)

Key findings

• The forecast fair value for Eternity Investment is HK$0.063 based on the 2-step Free Cash Flow to Equity
• With a share price of HK$0.075, Eternity Investment appears to be trading close to its estimated fair value

Today we’ll go through one way to estimate the intrinsic value of Eternity Investment Limited (HKG:764) by taking the expected future cash flows and discounting them to their present value. One way to do this is to apply 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.

We would like to point out that there are many ways to value a company and that each method, such as the DCF, has advantages and disadvantages in certain scenarios. For those who like to engage in stock analysis, the analysis model presented here by Simply Wall St might be of interest.

Check out our latest analysis for Eternity Investment

Step by step through the calculation

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.

In general, we assume that a dollar today is worth more than a dollar in the future. Therefore, we need to discount the sum of these future cash flows to arrive at an estimate of present value:

10-year free cash flow (FCF) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = HK$154 million

After calculating the present value of future cash flows in the first 10-year period, we need to calculate the terminal value that takes into account all future cash flows after the first period. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year Treasury yield of 2.2%. We discount the terminal cash flows to today’s value at a cost of equity of 13%.

Final value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = HK$32 million × (1 + 2.2%) ÷ (13% – 2.2%) = HK$296 million

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= HK$296 million ÷ ( 1 + 13 %)¹⁰= HK$86 million

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 HK$241 million. In the final step, we divide the equity value by the number of shares outstanding. Relative to the current share price of HK$0.07, the company is roughly at 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 this in mind.

Important assumptions

The above calculation relies heavily on two assumptions. The first is the discount rate and the other is the cash flows. If you disagree with these results, try the calculation yourself and play with the assumptions. 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 Eternity Investment 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 13%, which is based on a leveraged beta of 2,000. 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 Eternity Investment

Go on:

While the DCF calculation is important, it should not be the only metric you consider when researching a company. DCF models are not the be-all and end-all of investment valuation. You should preferably apply different cases and assumptions and see how they affect the valuation of the company. If a company grows at a different rate, or if its cost of equity or risk-free rate changes significantly, the result may look very different. For Eternity Investment, there are three essential elements to consider:

1. Risks: For this purpose, you should be aware of the 3 warning signs we discovered at Eternity Investment (including two potentially reputable ones).
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. Simply Wall St updates its DCF calculation for each Hong Kong stock daily, so if you want to find out the intrinsic value of another stock, 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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