Do Birlasoft Limited (NSE: BSOFT) Investors Pay Above Embedded Value?
How far away is Birlasoft Limited (NSE: BSOFT) of its intrinsic value? Using the most recent financial data, we’ll examine whether the stock price is fair by taking expected future cash flows and discounting them to today’s value. One way to do this is to use the Discounted Cash Flow (DCF) model. It may sound complicated, but it’s actually quite simple!
Remember, however, that there are many ways to estimate the value of a business, and a DCF is just one method. If you still have burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
Is Birlasoft valued enough?
We use the 2-step growth model, which simply means that we take into account two stages of business growth. In the initial period, the business can have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. To begin with, we need to get cash flow estimates for the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
In general, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year free cash flow (FCF) forecast
|Leverage FCF (₹, Millions)||₹ 3.86b||₹ 2.91b||₹ 3.69b||₹ 4.10b||₹ 4.50b||₹ 4.91b||₹ 5.31b||₹ 5.73b||6.17b||₹ 6.62b|
|Source of estimated growth rate||Analyst x3||Analyst x3||Analyst x3||Est @ 11.14%||Est @ 9.85%||Est @ 8.95%||Est @ 8.31%||Est @ 7.87%||East @ 7.56%||Est @ 7.35%|
|Present value (₹, Millions) discounted at 13%||₹ 3.4k||2.3k||2.5k||2.5k||₹ 2.4k||2.3k||2.2k||₹ 2.1k||₹ 2.0k||₹ 1.9k|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 24b
It is now a matter of calculating the Terminal Value, which takes into account all future cash flows after this ten-year 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 government bond yield of 6.8%. We discount terminal cash flows to their present value at a cost of equity of 13%.
Terminal value (TV)= FCF2030 × (1 + g) ÷ (r – g) = ₹ 6.6b × (1 + 6.8%) ÷ (13% – 6.8%) = ₹ 110b
Present value of terminal value (PVTV)= TV / (1 + r)ten= ₹ 110b ÷ (1 + 13%)ten= ₹ 32b
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is b55b. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of 267, the company looks potentially overvalued at the time of writing. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. If you don’t agree with these results, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we view Birlasoft 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 into account debt. In this calculation, we used 13%, which is based on a leveraged beta of 0.937. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
To move on :
Valuation is only one side of the coin in terms of building your investment thesis, and ideally, it won’t be the only piece of analysis you will look at for a business. It is not possible to achieve a rock-solid valuation with a DCF model. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. Can we understand why the company is trading at a premium over intrinsic value? For Birlasoft, we’ve compiled three relevant things that you should take a closer look at:
- Financial health: Does BSOFT have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors such as leverage and risk.
- Future benefits: How does BSOFT’s growth rate compare to that of its peers and the broader market? Deepen the number of analyst consensus for the coming years by interacting with our free chart of analysts’ growth expectations.
- Other strong companies: Low debt, high returns on equity, and good past performance are essential to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other businesses you may not have considered!
PS. Simply Wall St updates its DCF calculation for every Indian stock every day, so if you want to find the intrinsic value of any other stock, you just need to search here.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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