Fair value estimate of China Everbright Environment Group Limited (HKG:257)

Key findings

• Using the dividend discount model, the fair value of China Everbright Environment Group is estimated at HK$4.55.
• With a share price of HK$3.89, China Everbright Environment Group appears to be trading close to its estimated fair value
• The analyst price target of HK$4.04 for 257 is 11% below our fair value estimate

Today we will run through a valuation method to estimate the attractiveness of China Everbright Environment Group Limited (HKG:257) as an investment opportunity. We do this by projecting future cash flows and discounting them to today’s value. To do this, we will use the Discounted Cash Flow (DCF) model. Models like this may seem incomprehensible to a layperson, but they are relatively easy to follow.

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 is not without its flaws. For those who enjoy stock analysis, the Simply Wall St analysis model presented here might be of interest.

Check out our latest analysis for China Everbright Environment Group

What is the estimated value?

Because China Everbright Environment Group is in the commercial services business, we need to calculate intrinsic value a little differently. Instead of using free cash flows, which are difficult to estimate and often unreported by analysts in this industry, dividend payments per share (DPS) are used. Unless a company pays out the majority of its free cash flow as dividends, this method will typically underestimate the value of the stock. It uses the “Gordon Growth Model,” which simply assumes that dividend payments will continue to grow forever at a sustainable growth rate. For a number of reasons, a very conservative growth rate is used, which cannot exceed that of a company’s gross domestic product (GDP). In this case, we used the 5-year average of the 10-year Treasury bond yield (2.2%). The expected dividend per share is then discounted to today’s value using a cost of equity of 7.5%. Relative to the current share price of HK$3.9, the company appears to be roughly fairly valued at a 15% discount to the current share price. However, keep in mind that this is only an approximate valuation and that, as with any complex formula, where there’s garbage in, there’s garbage out.

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

= HK$0.2 / (7.5% – 2.2%)

= 4.6HK$

The assumptions

We would like to point out that the key inputs to a discounted cash flow are the discount rate and of course the actual 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 China Everbright Environment Group 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 7.5%, which is based on a leveraged beta of 0.973. 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 China Everbright Environment Group

Next Steps:

While the DCF calculation is important, it should not be the only metric you consider when researching 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 must 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 China Everbright Environment Group, we have compiled three key factors you should examine in more detail:

1. Risks: For this purpose, you should be aware of the 2 warning signs We discovered them at the China Everbright Environment Group (including one that should not be ignored).
2. Future income: How does 257’s growth rate compare to its peers 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 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!

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