Monday, March 8

Calculating The Fair Value Of Remedy Entertainment Oyj (HEL:REMEDY)


Today we’ll do a simple run through of a valuation method used to estimate the attractiveness of Remedy Entertainment Oyj (HEL:REMEDY) as an investment opportunity by projecting its future cash flows and then discounting them to today’s value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won’t be able to understand it, just read on! It’s actually much less complex than you’d imagine.

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.

See our latest analysis for Remedy Entertainment Oyj

Is Remedy Entertainment Oyj fairly valued?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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) forecast

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF (€, Millions) €8.00m €13.1m €18.2m €19.7m €24.0m €27.1m €29.5m €31.4m €32.8m €33.9m
Growth Rate Estimate Source Analyst x1 Analyst x1 Analyst x1 Analyst x1 Analyst x1 Est @ 12.77% Est @ 9.02% Est @ 6.4% Est @ 4.56% Est @ 3.28%
Present Value (€, Millions) Discounted @ 6.4% €7.5 €11.6 €15.1 €15.4 €17.6 €18.7 €19.1 €19.2 €18.8 €18.3

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = €161m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 0.3%. We discount the terminal cash flows to today’s value at a cost of equity of 6.4%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = €34m× (1 + 0.3%) ÷ (6.4%– 0.3%) = €558m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= €558m÷ ( 1 + 6.4%)10= €301m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is €462m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of €36.0, the company appears about fair value at a 5.9% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

HLSE:REMEDY Discounted Cash Flow January 20th 2021

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 Remedy Entertainment Oyj 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 6.4%, which is based on a levered beta of 1.048. 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.

Moving On:

Whilst important, the DCF calculation shouldn’t be the only metric you look at when researching 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?” For example, changes in the company’s cost of equity or the risk free rate can significantly impact the valuation. For Remedy Entertainment Oyj, we’ve put together three pertinent elements you should consider:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We’ve identified 1 warning sign with Remedy Entertainment Oyj , and understanding this should be part of your investment process.
  2. Future Earnings: How does REMEDY’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 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!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the HLSE every day. If you want to find the calculation for other stocks just search here.

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This article by Simply Wall St is general in nature. 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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.



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2 Comments

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