Yahoo Finance An Intrinsic Calculation For Lenovo Group Limited (HKG:992) Shows It’s 26.58% Undervalued
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I am going to run you through how I calculated the intrinsic value of Lenovo Group Limited (HKG:992) by taking the expected future cash flows and discounting them to today’s value. I will use the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not February 2019 then I highly recommend you check out the latest calculation for Lenovo Group by following the link below.
See our latest analysis for Lenovo Group
Is 992 fairly valued?
I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.
5-year cash flow forecast
2019 | 2020 | 2021 | 2022 | 2023 | |
Levered FCF ($, Millions) | $1.22k | $1.04k | $1.18k | $1.22k | $1.26k |
Source | Analyst x6 | Analyst x10 | Analyst x10 | Est @ 3.25% | Est @ 3.25% |
Present Value Discounted @ 11.5% | $1.10k | $836.17 | $850.44 | $787.53 | $729.28 |
Present Value of 5-year Cash Flow (PVCF)= US$4.3b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2%. We discount this to today’s value at a cost of equity of 11.5%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = US$1.3b × (1 + 2%) ÷ (11.5% – 2%) = US$13b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$13b ÷ ( 1 + 11.5%)5 = US$7.8b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$12b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of HK$7.93. Compared to the current share price of HK$5.82, the stock is about right, perhaps slightly undervalued at a 27% discount to what it is available for right now.
The assumptions
Now 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 my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Lenovo Group as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 11.5%, which is based on a levered beta of 1.188. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Next Steps:
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For 992, there are three key aspects you should look at:
Financial Health: Does 992 have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does 992’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: Are there other high quality stocks you could be holding instead of 992? 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 for every stock on the HKG every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
