The intrinsic value of Euromoney Institutional Investor PLC (LON: ERM) is potentially 30% above the share price

How far is Euromoney Institutional Investor PLC (LON: ERM) from its intrinsic value? Using the latest financial data, we verify that the stock is fairly valued by discounting the company’s forecast future cash flows to today’s value. One way to achieve this is to use the discounted cash flow (DCF) model. Models like this may seem incomprehensible to a layperson, but they are pretty easy to follow.

We point out that there are many ways to evaluate a company and, as with DCF, each method has advantages and disadvantages in certain scenarios. If you want to find out more about the intrinsic value, you should read through the Simply Wall St analysis model.

Check out our latest analysis for Euromoney Institutional Investor

Crack the numbers

We use the 2-step growth model, which simply means that we consider two phases of growth for the company. In the initial phase the company can show a higher growth rate and in the second phase a stable growth rate is normally assumed. First, we need to estimate the cash flows for the next ten years. We use analyst estimates wherever possible, but when these are not available we extrapolate the previous free cash flow (FCF) from the most recent estimate or reported value. We assume that companies with falling free cash flow will slow their rate of contraction and that companies with increasing free cash flow will slow their growth rate over this period. We do this to take into account that growth tends to slow down more in the first few years than in later years.

A DCF is all about the idea that a dollar in the future is worth less than a dollar today, so we need to discount the sum of these future cash flows to get a present value estimate:

10-year free cash flow (FCF) forecast

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

Levered FCF (£ million)

£ 55.4 million

UK £ 70.9m

UK £ 72.5m

UK £ 73.8m

UK £ 75.0m

UK £ 76.0m

UK £ 77.0m

UK £ 77.9m

UK £ 78.7m

UK £ 79.5m

Source of the growth rate estimate

Analyst x4

Analyst x4

Estimate @ 2.26%

Estimated @ 1.86%

Estimated @ 1.58%

Estimate @ 1.38%

Estimated @ 1.24%

Estimated @ 1.15%

Estimated at 1.08%

Estimated at 1.03%

Present value (£. Million) discounted by 5.8%

€ 52.4

UK £ 63.3

£ 61.2

UK £ 58.9

UK £ 56.5

UK € 54.2

€ 51.8

£ 49.5

UK £ 47.3

£ 45.2

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = £ 540m

We now need to calculate the Terminal Value, which takes into account all future cash flows after this ten year period. The Gordon growth formula is used to calculate the terminal value using a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 0.9%. We discount the terminal cash flows to today’s value using a cost of equity of 5.8%.

Final value (TV)= FCF2031 × (1 + g) ÷ (r – g) = UK £ 80m × (1 + 0.9%) ÷ (5.8% – 0.9%) = UK £ 1.6 billion

Present value of the final value (PVTV)= TV / (1 + r)10= UK £ 1.6bn ÷ (1 + 5.8%)10= 931 million GB

The total value or equity value is then the sum of the present value of future cash flows, which in this case is £ 1.5bn. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of 10.5 pounds sterling, the company appears a bit undervalued at a discount of 23% on the current share price. Ratings, however, are inaccurate instruments, much like a telescope – move a few degrees and land in a different galaxy. Keep this in mind.

dcf

The assumptions

The most important input factors for a discounted cash flow are now the discount rate and of course the actual cash flows. Part of investing is making your own assessment of a company’s future performance, so try the calculation yourself and review your own assumptions. The DCF also does not take into account the possible cyclical nature of an industry or the future capital requirements of a company, so that it does not provide a complete picture of the potential performance of a company. Because we consider Euromoney Institutional Investor 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 into account debt. In this calculation we used 5.8% which is based on a leveraged beta of 0.923. Beta is a measure of the volatility of a stock compared to the overall market. 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 stable business.

Next Steps:

Rating is only one side of the coin when it comes to creating your investment thesis, and it shouldn’t be the only metric you consider when researching a company. DCF models are not the be-all and end-all of asset valuation. The best thing to do is to apply different cases and assumptions and see how they affect the company’s valuation. If a company is growing differently, or if the cost of equity or the risk-free interest rate changes dramatically, the outcome may be very different. Why is the intrinsic value higher than the current share price? For Euromoney Institutional Investor, there are three other things to consider:

  1. Financial health: Does the ERM have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors such as leverage and risk.

  2. Future income: What is ERM’s growth rate compared to competitors and the broader market? Learn more about analyst consensus numbers for the years to come by interacting with our free analyst growth expectations chart.

  3. Other solid deals: Low debt, high returns on equity, and good past performance are fundamental to a strong business. Explore our interactive list of stocks with a solid business foundation to see if there are any other companies you might not have considered!

PS. Simply Wall St updates its DCF calculation for every UK share on a daily basis. So if you want to find out the intrinsic value of any other stock, just search here.

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

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

About Nina Snider

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