Key Insights

Craneware's estimated fair value is UK£10.18 based on 2 Stage Free Cash Flow to Equity Current share price of UK£13.30 suggests Craneware is potentially 31% overvalued Our fair value estimate is 61% lower than Craneware's analyst price target of US$25.77

In this article we are going to estimate the intrinsic value of Craneware plc (LON:CRW) by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for Craneware

Crunching The Numbers

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 start off with, we need to estimate 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 Levered FCF ($, Millions)  US$22.3m US$22.4m US$26.7m US$29.8m US$32.4m US$34.4m US$36.1m US$37.5m US$38.6m US$39.5m Growth Rate Estimate Source Analyst x4 Analyst x4 Analyst x4 Est @ 11.74% Est @ 8.59% Est @ 6.39% Est @ 4.84% Est @ 3.76% Est @ 3.00% Est @ 2.48% Present Value ($, Millions) Discounted @ 8.6%  US$20.6 US$19.0 US$20.8 US$21.4 US$21.5 US$21.0 US$20.3 US$19.4 US$18.4 US$17.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$200m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (1.2%) 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 8.6%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$40m× (1 + 1.2%) ÷ (8.6%– 1.2%) = US$546m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$546m÷ ( 1 + 8.6%)10= US$240m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$440m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of UK£13.3, the company appears potentially overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent. 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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Craneware 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 8.6%, which is based on a levered beta of 1.052. 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 Craneware

Strength

Debt is not viewed as a risk.

Weakness

Earnings declined over the past year.

Dividend is low compared to the top 25% of dividend payers in the Healthcare Services market.

Expensive based on P/E ratio and estimated fair value.

Opportunity

Annual earnings are forecast to grow faster than the British market.

Significant insider buying over the past 3 months.

Threat

Dividends are not covered by earnings.

Revenue is forecast to grow slower than 20% per year.

Next Steps:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or 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. What is the reason for the share price exceeding the intrinsic value? For Craneware, there are three relevant factors you should consider:

Risks: We feel that you should assess the 2 warning signs for Craneware we've flagged before making an investment in the company. Future Earnings: How does CRW'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every British stock every day, so if you want to find the intrinsic value of any other stock 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