Microlise Group's estimated fair value is UK￡1.14 based on 2 Stage Free Cash Flow to Equity
Microlise Group is estimated to be 21% overvalued based on current share price of UK￡1.39
In this article we are going to estimate the intrinsic value of Microlise Group plc (LON:SAAS) by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. 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.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF (￡, Millions)
UK￡5.76m
UK￡6.40m
UK￡6.87m
UK￡7.26m
UK￡7.58m
UK￡7.86m
UK￡8.10m
UK￡8.32m
UK￡8.52m
UK￡8.71m
Growth Rate Estimate Source
Analyst x2
Analyst x1
Est @ 7.31%
Est @ 5.65%
Est @ 4.49%
Est @ 3.67%
Est @ 3.10%
Est @ 2.70%
Est @ 2.42%
Est @ 2.23%
Present Value (￡, Millions) Discounted @ 7.2%
UK￡5.4
UK￡5.6
UK￡5.6
UK￡5.5
UK￡5.4
UK￡5.2
UK￡5.0
UK￡4.8
UK￡4.6
UK￡4.3
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = UK￡51m
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 1.8%. We discount the terminal cash flows to today's value at a cost of equity of 7.2%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK￡163m÷ ( 1 + 7.2%)10= UK￡81m
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 UK￡133m. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of UK￡1.4, the company appears slightly overvalued 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
Important Assumptions
We would point out 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 inputs, I recommend redoing the calculations yourself and playing with them. 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 Microlise 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 7.2%, which is based on a levered beta of 0.992. 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 Microlise Group
Strength
Currently debt free.
Weakness
Earnings growth over the past year underperformed the Software industry.
Dividend is low compared to the top 25% of dividend payers in the Software market.
Expensive based on P/E ratio and estimated fair value.
Opportunity
Annual earnings are forecast to grow faster than the British market.
Threat
Dividends are not covered by earnings.
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. 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price exceeding the intrinsic value? For Microlise Group, we've put together three relevant factors you should consider:
Future Earnings: How does SAAS'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: 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. Simply Wall St updates its DCF calculation for every British stock every day, so if you want to find the intrinsic value of any other stock just search here.
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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.
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