Shares of Tech Mahindra Limited ( NSE:TECHM ) could be 27% above their intrinsic valuation | Jobs Vox

How far is Tech Mahindra Limited (NSE:TECHM) from its intrinsic value? Using recent financial data, we’ll look at whether a stock is priced fairly by projecting its future cash flows and then discounting them to today’s value. One way to achieve this is by using the discounted cash flow (DCF) model. Believe it or not, it’s not hard to follow, as you’ll see from our example!

However, remember that there are many ways to value a company, and DCF is just one method. Anyone interested in learning more about intrinsic value should read the Simply Wall St. analysis model.

Look opportunities and risks within the IN IT industry.

Step by step through the calculation

We will use a two-stage DCF model, which, as the name suggests, takes into account two stages of growth. The first phase is generally a higher period of growth that descends towards the bottom value, caught in a second period of ‘stable growth’. In the first phase, we need to estimate the cash flows to the business over the next ten years. We use analyst estimates where possible, but when these are not available, we extrapolate forward free cash flow (FCF) from the most recent estimate or reported value. We hypothesize that companies with reduced free cash flow will slow their rate of reduction, and companies with increasing free cash flow will have a slower growth rate during this period. We do this to reflect that growth tends to slow more in the early years than in the later years.

We generally assume that a dollar today is worth more than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today’s dollars:

10-year free cash flow (FCF) forecast.

	in 2023	in 2024	in 2025	in 2026	in 2027	in 2028	2029	2030	2031	2032
Debt FKF (INR millions)	₹43.9b	₹57.6b	₹61.3b	₹63.5b	₹66.3b	₹69.7b	₹73.6b	₹78.0b	₹82.8b	₹88.1b
Source of growth rate estimates	Analyst k20	Analyst k20	Analyst x10	Analyst k1	Valuation @ 4.37%	Estimate @ 5.1%	Valuation @ 5.61%	Valuation @ 5.96%	Valuation @ 6.21%	Valuation @ 6.38%
Present value (INR millions) discounted at 14%	₹38.5k	₹44.4k	₹41.5k	₹37.7k	₹34.6k	₹31.9k	₹29.6k	₹27.5k	₹25.6k	₹23.9k

(“Estimation” = FCF growth rate estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = ₹335b

Now we need to calculate the terminal value, which includes all future cash flows after this ten-year period. For several reasons, a very conservative growth rate is used, which cannot exceed the GDP growth rate of a country. In this case, we used the 5-year average yield on 10-year government bonds (6.8%) to estimate future growth. In the same way as with the 10-year ‘growth’ period, we discount the future cash flows to today’s value, using a cost of capital of 14%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = ₹88b× (1 + 6.8%) ÷ (14%– 6.8%) = ₹1.3t

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 1.3 t÷ ( 1 + 14%)¹⁰= ₹359b

The total value is the sum of the cash flows for the next ten years plus the discounted terminal value, which results in the total capital value, which in this case is 694 b. ₹. In the final step, we divide the capital value by the number of shares. Compared to the current share price of INR 1.0K, the company appears to be slightly overvalued at the time of writing. Note that this is only a rough estimate, and like any complex formula – garbage in, garbage out.

Important assumptions

We would point out that the most important inputs for the discounted cash flow are the discount rate and of course the actual cash flows. If you do not agree with this result, go to the calculation yourself and play with the assumptions. DCF also does not take into account possible industry cyclicality, or a company’s future capital requirements, so it does not give a complete picture of a company’s potential performance. Since we are looking at Tech Mahindra as potential shareholders, the cost of capital is used as the discount rate rather than the cost of capital (or weighted average cost of capital, VACC) which includes debt. In this calculation we used 14%, which is based on a leveraged beta of 1.007. Beta is a measure of a stock’s volatility, compared to the market as a whole. We derive our beta from the 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.

Looking ahead:

Valuation is only one side of the coin in terms of building your investment case, and it shouldn’t be the only metric you look at when researching a company. It is not possible to obtain a reliable estimate using the DCF model. It is advisable to apply different cases and assumptions and see how they will affect the valuation of the company. For example, changes in the company’s cost of capital or the risk-free rate can significantly affect the valuation. Why is the intrinsic value lower than the current share price? For Tech Mahindra, there are three essential elements to consider:

1. Risks: Every company has them, and we noticed 1 warning sign for Tech Mahindra you should know about.
2. Future earnings: How does TECHM’s growth rate compare to its peers and the broader market? Dig deeper into the analyst consensus for the coming years by interacting with our free Analyst Growth Expected Chart.
3. Other solid companies: 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 Simpli Wall St app conducts discounted cash flow valuations for each stock on the NSEI each day. If you want to find a calculation for other actions, just search here.

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This Simply Wall St article 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 into account your goals or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simpli Wall St has no position in any of the stocks mentioned.