Key Insights

The projected fair value for SGH is AU$62.81 based on 2 Stage Free Cash Flow to Equity Current share price of AU$50.51 suggests SGH is potentially trading close to its fair value The AU$51.48 analyst price target for SGH is 18% less than our estimate of fair value

Does the August share price for SGH Limited (ASX:SGH) 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 today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

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The Model

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over 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 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) forecast

2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 Levered FCF (A$, Millions)  AU$935.7m AU$932.3m AU$1.10b AU$1.32b AU$1.40b AU$1.47b AU$1.54b AU$1.60b AU$1.66b AU$1.71b Growth Rate Estimate Source Analyst x3 Analyst x3 Analyst x3 Analyst x1 Analyst x1 Est @ 4.91% Est @ 4.37% Est @ 3.99% Est @ 3.73% Est @ 3.54% Present Value (A$, Millions) Discounted @ 8.0%  AU$866 AU$799 AU$876 AU$969 AU$954 AU$927 AU$896 AU$863 AU$828 AU$794

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU$8.8b

Story Continues

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 3.1%. We discount the terminal cash flows to today's value at a cost of equity of 8.0%.

Terminal Value (TV)= FCF2035 × (1 + g) ÷ (r – g) = AU$1.7b× (1 + 3.1%) ÷ (8.0%– 3.1%) = AU$36b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU$36b÷ ( 1 + 8.0%)10= AU$17b

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 AU$26b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of AU$50.5, the company appears about fair value at a 20% 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.ASX:SGH Discounted Cash Flow August 30th 2025

The 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 SGH 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 8.0%, which is based on a levered beta of 1.162. 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.

Check out our latest analysis for SGH

SWOT Analysis for SGH

Strength

Earnings growth over the past year exceeded its 5-year average.

Debt is well covered by earnings and cashflows.

Weakness

Earnings growth over the past year underperformed the Trade Distributors industry.

Dividend is low compared to the top 25% of dividend payers in the Trade Distributors market.

Opportunity

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

Current share price is below our estimate of fair value.

Threat

Annual revenue is forecast to grow slower than the Australian market.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. 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. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For SGH, we've compiled three essential aspects you should look at:

Risks: We feel that you should assess the 1 warning sign for SGH we've flagged before making an investment in the company. Future Earnings: How does SGH'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. 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.

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