Key Insights
- Using the Dividend Discount Model, Guoco Group fair value estimate is HK$45.87
- Current share price of HK$55.00 suggests Guoco Group is potentially trading close to its fair value
- Guoco Group's peers are currently trading at a discount of 32% on average
In this article we are going to estimate the intrinsic value of Guoco Group Limited (HKG:53) by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
View our latest analysis for Guoco Group
What's The Estimated Valuation?
We have to calculate the value of Guoco Group slightly differently to other stocks because it is a industrials company. Instead of using free cash flows, which are hard to estimate and often not reported by analysts in this industry, dividends per share (DPS) payments are used. Unless a company pays out the majority of its FCF as a dividend, this method will typically underestimate the value of the stock. The 'Gordon Growth Model' is used, which simply assumes that dividend payments will continue to increase at a sustainable growth rate forever. The dividend is expected to grow at an annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We then discount this figure to today's value at a cost of equity of 8.5%. Relative to the current share price of HK$55.0, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
Value Per Share = Expected Dividend Per Share / (Discount Rate - Perpetual Growth Rate)
= US$0.4 / (8.5% – 2.0%)
= HK$45.9
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 Guoco Group 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 8.5%, which is based on a levered beta of 1.103. 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 Guoco Group
- Earnings growth over the past year exceeded the industry.
- Net debt to equity ratio below 40%.
- Dividends are covered by earnings and cash flows.
- Dividend information for 53.
- Interest payments on debt are not well covered.
- Dividend is low compared to the top 25% of dividend payers in the Industrials market.
- Current share price is above our estimate of fair value.
- 53's financial characteristics indicate limited near-term opportunities for shareholders.
- Lack of analyst coverage makes it difficult to determine 53's earnings prospects.
- Debt is not well covered by operating cash flow.
- Is 53 well equipped to handle threats?
Moving On:
Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Guoco Group, there are three essential aspects you should explore:
- Risks: For example, we've discovered 3 warning signs for Guoco Group (1 is concerning!) that you should be aware of before investing here.
- 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!
- Other Top Analyst Picks: Interested to see what the analysts are thinking? Take a look at our interactive list of analysts' top stock picks to find out what they feel might have an attractive future outlook!
PS. Simply Wall St updates its DCF calculation for every Hong Kong stock every day, so if you want to find the intrinsic value of any other stock 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.