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A Look At The Fair Value Of Li Auto Inc. (NASDAQ:LI)

Key Insights

  • The projected fair value for Li Auto is US$29.33 based on 2 Stage Free Cash Flow to Equity

  • Li Auto's US$30.68 share price indicates it is trading at similar levels as its fair value estimate

  • The CN¥52.22 analyst price target for LI is 78% more than our estimate of fair value

In this article we are going to estimate the intrinsic value of Li Auto Inc. (NASDAQ:LI) by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!

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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View our latest analysis for Li Auto

The Calculation

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF (CN¥, Millions)

CN¥20.9b

CN¥25.6b

CN¥32.4b

CN¥21.6b

CN¥23.1b

CN¥22.1b

CN¥21.6b

CN¥21.4b

CN¥21.4b

CN¥21.5b

Growth Rate Estimate Source

Analyst x10

Analyst x10

Analyst x3

Analyst x1

Analyst x1

Est @ -4.34%

Est @ -2.35%

Est @ -0.96%

Est @ 0.02%

Est @ 0.70%

Present Value (CN¥, Millions) Discounted @ 12%

CN¥18.7k

CN¥20.5k

CN¥23.2k

CN¥13.8k

CN¥13.2k

CN¥11.3k

CN¥9.9k

CN¥8.8k

CN¥7.8k

CN¥7.1k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥134b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 12%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = CN¥22b× (1 + 2.3%) ÷ (12%– 2.3%) = CN¥232b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= CN¥232b÷ ( 1 + 12%)10= CN¥76b

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 CN¥210b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$30.7, the company appears around fair value at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
dcf

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. 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 Li Auto 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 12%, which is based on a levered beta of 1.687. 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 Li Auto

Strength

  • Debt is not viewed as a risk.

Weakness

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

  • Shareholders have been diluted in the past year.

Opportunity

  • Annual earnings are forecast to grow faster than the American market.

Threat

  • No apparent threats visible for LI.

Looking Ahead:

Whilst important, the DCF calculation 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 need to 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 significantly impact the valuation. For Li Auto, we've put together three further elements you should explore:

  1. Risks: Every company has them, and we've spotted 1 warning sign for Li Auto you should know about.

  2. Future Earnings: How does LI'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.

  3. Other High Quality Alternatives: Do you like a good all-rounder? 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 valuation for every stock on the NASDAQGS 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.