Key Insights

Using the 2 Stage Free Cash Flow to Equity, Elanor Investors Group fair value estimate is AU$1.85 Current share price of AU$1.70 suggests Elanor Investors Group is potentially trading close to its fair value Industry average discount to fair value of 8.7% suggests Elanor Investors Group's peers are currently trading at a higher discount

Does the July share price for Elanor Investors Group (ASX:ENN) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for Elanor Investors Group

Is Elanor Investors Group Fairly Valued?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of 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 companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 Levered FCF (A$, Millions)  AU$25.7m AU$27.2m AU$28.4m AU$29.4m AU$30.3m AU$31.1m AU$31.9m AU$32.6m AU$33.4m AU$34.1m Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ 4.24% Est @ 3.56% Est @ 3.08% Est @ 2.74% Est @ 2.51% Est @ 2.34% Est @ 2.23% Est @ 2.15% Present Value (A$, Millions) Discounted @ 12%  AU$22.9 AU$21.5 AU$20.0 AU$18.4 AU$16.9 AU$15.4 AU$14.1 AU$12.8 AU$11.7 AU$10.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$164m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 12%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = AU$34m× (1 + 2.0%) ÷ (12%– 2.0%) = AU$333m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$333m÷ ( 1 + 12%)10= AU$104m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU$268m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of AU$1.7, the company appears about fair value at a 7.9% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out. dcf

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Elanor Investors 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 accounts for debt. In this calculation we've used 12%, which is based on a levered beta of 1.755. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Elanor Investors Group

Strength

Dividend is in the top 25% of dividend payers in the market.

Weakness

Interest payments on debt are not well covered.

Shareholders have been diluted in the past year.

Opportunity

Expected to breakeven next year.

Current share price is below our estimate of fair value.

Threat

Debt is not well covered by operating cash flow.

Has less than 3 years of cash runway based on current free cash flow.

Paying a dividend but company is unprofitable.

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Elanor Investors Group, we've put together three further items you should consider:

Risks: For example, we've discovered 2 warning signs for Elanor Investors Group (1 makes us a bit uncomfortable!) that you should be aware of before investing here. Future Earnings: How does ENN's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart. 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 is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the ASX every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here