Calculation of the intrinsic value of Art’s-Way Manufacturing Co., Inc. (NASDAQ: ARTW)
Today we are going to take a simple overview of a valuation method used to estimate the attractiveness of Art’s-Way Manufacturing Co., Inc. (NASDAQ: ARTW) as an investment opportunity. by projecting its future cash flows and then discounting them to present value. . One way to do this is to use the Discounted Cash Flow (DCF) model. It may sound complicated, but it’s actually quite simple!
Remember, however, that there are many ways to estimate the value of a business and that a DCF is just one method. If you still have burning questions about this type of assessment, take a look at the Simply Wall St analysis model.
Discover our latest analysis for Art’s-Way Manufacturing
Crunch the numbers
We use the 2-step growth model, which simply means that we take into account two stages of business growth. During the initial period, the business can have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we need to get cash flow estimates for the next ten years. Since no analysts estimate of free cash flow is available to us, we have extrapolated past free cash flow (FCF) from the last reported value of the company. We assume that companies with decreasing free cash flow will slow their withdrawal rate, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect that growth tends to slow down more in the early years than in the later years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and therefore the sum of these future cash flows is then discounted to present value:
10-year free cash flow (FCF) estimate
|Levered FCF ($, million)||US $ 166.7K||US $ 284.3K||US $ 426.3K||US $ 578.0K||US $ 725.4K||US $ 859.3K||US $ 975.4K||$ 1.07 million||$ 1.16 million||$ 1.22 million|
|Source of estimated growth rate||Is 99.92%||Is 70.54%||Is 49.98%||Is at 35.58%||Is 25.5%||Is 18.45%||Is 13.51%||Is at 10.05%||Is 7.64%||Is 5.94%|
|Present value ($, millions) discounted at 7.8%||0.2 USD||0.2 USD||$ 0.3||0.4 USD||0.5 USD||0.5 USD||0.6 USD||0.6 USD||0.6 USD||0.6 USD|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = $ 4.0 million
After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. For a number of reasons, a very conservative growth rate is used that cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 7.8%.
Terminal value (TV)= FCF2030 × (1 + g) ÷ (r – g) = $ 1.2 million × (1 + 2.0%) ÷ (7.8% – 2.0%) = $ 22 million
Present value of terminal value (PVTV)= TV / (1 + r)ten= 22 million USD ÷ (1 + 7.8%)ten= 10 million USD
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is US $ 14 million. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of US $ 3.2, the company is around fair value at the time of writing. Remember though, this is only a rough estimate, and like any complex formula – garbage in, garbage out.
We draw your attention to the fact that the most important data for a discounted cash flow is the discount rate and, of course, the actual cash flow. You don’t have to agree with these entries, I recommend that you redo the math yourself and play around with it. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we view Art’s-Way Manufacturing 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 takes debt into account. In this calculation, we used 7.8%, which is based on a leveraged beta of 1.221. Beta is a measure of the volatility of a stock, relative 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.
Valuation is only one side of the coin in terms of building your investment thesis, and it’s just one of the many factors you need to evaluate for a business. It is not possible to obtain an infallible valuation with a DCF model. Preferably, you would apply different cases and assumptions and see how they would impact the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For Art’s-Way Manufacturing, we have compiled three relevant elements that you should explore:
- Risks: As an example, we found 3 warning signs for Art’s-Way Manufacturing (1 cannot be ignored!) Which you must consider before investing here.
- Other strong companies: Low debt, high returns on equity, and good past performance are essential to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you may not have considered!
- Other Best Analyst Picks: Interested in seeing what analysts think? Take a look at our interactive list of analysts’ top stock picks to find out what they think might have a compelling outlook for the future!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each NASDAQCM share. If you want to find the calculation for other actions, just search here.
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