A look at the fair value of ZOO Digital Group plc (LON:ZOO)

Important Findings

• The estimated fair value of ZOO Digital Group is £2.16 based on 2-step free cash flow to equity

• The current UK share price of £2.08 suggests that ZOO Digital Group may be trading close to its fair value

• Our fair value estimate is 25% above ZOO Digital Group analysts’ price target of $2.70

In this article, we’re going to estimate the intrinsic value of ZOO Digital Group plc (LON:ZOO) by taking the company’s projected future cash flows and discounting them to today’s value. We use the discounted cash flow (DCF) model. It may sound complicated, but it’s actually quite simple!

We generally believe that a company’s value is the present value of all the cash it will generate in the future. However, a DCF is just one evaluation metric among many, and it is not without its shortcomings. If you still have burning questions about this type of assessment, take a look at Simply Wall St’s analytics model.

Check out our latest analysis for ZOO Digital Group

The method

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 growth phase that levels off towards the terminal value captured in the second phase of ‘steady growth’. In the first phase, we need to estimate the cash flows for the company over the next ten years. Where possible we use analyst estimates, but when these are not available we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We expect companies with declining free cash flow to slow their rate of contraction and companies with growing free cash flow to slow their growth rate over this period. We do this to take into account that growth tends to slow down more in the early years than in later years.

In general, we assume a dollar is more valuable today than a dollar will be in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

The story goes on

10-year free cash flow (FCF) estimate.

(“Est” = FCF growth rate estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = $96 million

We now need to calculate the terminal value, which takes into account all future cash flows after that 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 10-year government bond yield of 1.2%. We discount the final cash flows to today’s value using a cost of equity rate of 8.2%.

final value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = $21M × (1 + 1.2%) ÷ (8.2% – 1.2%) = $304M

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= $304M÷ ( 1 + 8.2%)¹⁰= $139 million

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is $235 million. The final step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of £2.1, the company appears about fair value at a discount of 3.9% to the current share price. However, ratings are inaccurate instruments, more like a telescope – move a few degrees and end up in another galaxy. Remember.

The Assumptions

We would like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don’t agree with these results, try the calculation yourself and play with the assumptions. The DCF also does not take into account the potential cyclicality of an industry or a company’s future capital needs, so it does not provide a complete picture of a company’s potential performance. As we consider ZOO Digital Group as a potential shareholder, the cost of equity is used as the discount rate and not the cost of capital (or weighted average cost of capital, WACC) which takes debt into account. In this calculation we used 8.2% which is based on a leveraged beta of 1.010. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the industry average of global peers, with an imposed limit of between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for the ZOO Digital Group

Strength

weakness

Opportunity

Danger

Further:

Valuation is only one side of the coin when it comes to creating your investment thesis, and it’s just one of many factors you need to evaluate for a company. The DCF model is not a perfect stock valuation tool. Preferably you would apply different cases and assumptions and see how they would affect the company’s valuation. For example, changes in the company’s cost of equity or the risk-free rate can significantly affect the valuation. For the ZOO Digital Group we have compiled three important elements that you should consider:

1. financial health: Does ZOO have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.

2. future earnings: How does ZOO’s growth rate compare to its competitors and the broader market? Dive deeper into analyst consensus numbers for the years ahead by interacting with our free analyst growth expectations chart.

3. Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of quality stocks to get an idea of ​​what else you might be missing!

hp The Simply Wall St app runs a discounted cash flow valuation for each stock on the AIM every day. If you want to find the calculation for other stocks, just search here.

Do you have any feedback about this article? Concerned about the content? Get in touch directly with us. Alternatively, send an email to the editorial team (at) simplywallst.com.

This Simply Wall St article is of a general nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock and does not take into account your goals or financial situation. Our goal is to offer you long-term focused analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned.

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