Estimating the intrinsic value of Berkeley Group Holdings plc (LON:BKG)

Key findings

• The estimated fair value of Berkeley Group Holdings is £43.33 based on 2-step free cash flow to equity
• The current share price of £47.08 suggests that Berkeley Group Holdings may be trading close to its fair value
• Our fair value estimate is 12% below Berkeley Group Holdings’ analyst price target of GBP49.26.

Today we’re going to walk through one way to estimate the intrinsic value of The Berkeley Group Holdings plc (LON:BKG) by projecting future cash flows and then discounting those to today’s value. We’re going to use the Discounted Cash Flow (DCF) model on this occasion. Before you think you can’t understand it, just read on! 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 method. 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 Berkeley Group Holdings

Processing the numbers

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. In the first stage, we need to estimate the company’s cash flows for the next ten years. 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.

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) = £2.2 billion

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 1.8%. We discount the terminal cash flows to today’s value at a cost of equity of 9.0%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = £400 million × (1 + 1.8%) ÷ (9.0% – 1.8%) = £5.6 billion

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= £5.6 billion ÷ (1 + 9.0%)¹⁰= £2.4 billion

The total value or equity value is then the sum of the present value of future cash flows, which in this case is £4.6 billion. To get the intrinsic value per share, we divide this by the total number of shares in issue. Relative to the current share price of £47.1, the company seems about fair at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it’s better to think of this as a rough estimate that isn’t accurate to the last penny.

Important assumptions

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 Berkeley Group Holdings as prospective 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 9.0%, which is based on a levered beta of 1.315. 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 Berkeley Group Holdings

Next Steps:

Valuation is only one side of the coin when building your investment thesis and should not be the only metric you consider when researching 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 Berkeley Group Holdings, we have compiled three other aspects that you should examine in more detail:

1. Risks: Take risks, for example – Berkeley Group Holdings has 1 warning sign In our opinion, you should be aware of this.
2. Future income: How is BKG’s growth rate compared to 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: Like a good all-rounder? Explore our interactive list of high-quality stocks to get a sense of what else you might be missing out on!

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