Today, we’ll walk through one way to estimate the intrinsic value of Oriental Culture Holding LTD (NASDAQ:OCG) by projecting its future cash flows and then discounting them to the present value. On this occasion, we will use the Discounted Cash Flow (DCF) model. There really isn’t much to do, although it may seem quite complex.
Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. For those who are passionate about stock analysis, the Simply Wall St analysis template here may interest you.
What is the estimated value?
We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. In the first step, we need to estimate the company’s cash flow over the next ten years. Since no analyst estimate of free cash flow is available, we have extrapolated the previous free cash flow (FCF) from the company’s latest reported 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 more in 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, so we discount the value of these future cash flows to their estimated value in today’s dollars:
10-Year Free Cash Flow (FCF) Forecast
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Leveraged FCF ($, millions) | $2.68 million | $2.44m | $2.30 million | $2.22 million | $2.18 million | $2.17 million | $2.17 million | US$2.19m | $2.21 million | $2.24 million |
Growth rate estimate Source | Is @ -13.56% | Is @ -8.91% | East @ -5.66% | Is @ -3.38% | Is @ -1.78% | Is @ -0.67% | Is at 0.12% | Is at 0.66% | Is at 1.05% | Is at 1.31% |
Present value (millions of dollars) discounted at 6.9% | $2.5 | $2.1 | $1.9 | $1.7 | $1.6 | $1.5 | $1.4 | $1.3 | $1.2 | $1.1 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $16 million
The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.9%. We discount the terminal cash flows to present value at a cost of equity of 6.9%.
Terminal value (TV)= FCF_{2032} × (1 + g) ÷ (r – g) = $2.2 million × (1 + 1.9%) ÷ (6.9%–1.9%) = $46 million
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= $46 million ÷ (1 + 6.9%)^{ten}= $23 million
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $39 million. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of $2.2, the company appears to be roughly fair value at the time of writing. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep that in mind.
The hypotheses
We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play around with them. 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 consider Oriental Culture Holding 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 debt into account. In this calculation, we used 6.9%, which is based on a leveraged beta of 1.031. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Let’s move on :
Valuation is only one side of the coin in terms of crafting your investment thesis, and it shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under/overvalued?” For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. For Oriental Culture Holding, there are three relevant items you should consider:
- Risks: Take for example the ubiquitous specter of investment risk. We have identified 2 warning signs with Oriental Culture Holding, and understanding them should be part of your investment process.
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
- Other top analyst picks: Interested to see what the analysts think? Take a look at our interactive list of analysts’ top stock picks to find out what they think could have attractive future prospects!
PS. The Simply Wall St app performs a daily updated cash flow assessment for each NASDAQCM stock. If you want to find the calculation for other stocks, search here.
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