Key Insights

• The projected fair value for Finbar Group is AU$1.05 based on Dividend Discount Model

• Finbar Group's AU$0.90 share price indicates it is trading at similar levels as its fair value estimate

• Finbar Group's peers are currently trading at a premium of 61% on average

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Finbar Group Limited (ASX:FRI) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing 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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Finbar Group

Crunching The Numbers

We have to calculate the value of Finbar Group slightly differently to other stocks because it is a real estate 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. This often underestimates the value of a stock, but it can still be good as a comparison to competitors. The 'Gordon Growth Model' is used, which simply assumes that dividend payments will continue to increase at a sustainable growth rate forever. For a number of reasons a very conservative growth rate is used that cannot exceed that of a company's Gross Domestic Product (GDP). In this case we used the 5-year average of the 10-year government bond yield (2.4%). The expected dividend per share is then discounted to today's value at a cost of equity of 8.0%. Compared to the current share price of AU$0.9, the company appears about fair value at a 14% discount to where the stock price trades currently. 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)

= AU$0.08 / (8.0% – 2.4%)

= AU$1.0

The Assumptions

Now 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 Finbar 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 8.0%, which is based on a levered beta of 1.360. 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 Finbar Group

Strength

• Earnings growth over the past year exceeded the industry.

• Debt is well covered by earnings.

• Dividend is in the top 25% of dividend payers in the market.

Weakness

• No major weaknesses identified for FRI.

Opportunity

• Current share price is below our estimate of fair value.

• Significant insider buying over the past 3 months.

• Lack of analyst coverage makes it difficult to determine FRI's earnings prospects.

Threat

• Debt is not well covered by operating cash flow.

• Dividends are not covered by earnings.

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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. For Finbar Group, there are three further aspects you should look at:

1. Risks: As an example, we've found 3 warning signs for Finbar Group that you need to consider before investing here.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for FRI's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

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. Simply Wall St updates its DCF calculation for every Australian 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.