Calculation of the fair value of Mahindra & Mahindra Limited (NSE: M&M)
Today we are going to review a valuation method used to estimate the attractiveness of Mahindra & Mahindra Limited (NSE: M&M) as an investment opportunity by taking expected future cash flows and discounting them. at their current value. We will use the Discounted Cash Flow (DCF) model on this occasion. There really isn’t much to do, although it might seem quite complex.
We draw your attention to the fact that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.
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We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. To begin with, we need to estimate the next ten years of cash flow. Since no free cash flow analyst estimate is available, we have extrapolated the previous free cash flow (FCF) from the last reported value of the company. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
In general, we 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) estimate
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leverage FCF (₹, Millions) | 121.0b | 131.0b | 141.1b | 151.7b | 162.7b | 174.2b | 186.4b | 199.3b | 213.0b | 227.5b |
Source of estimated growth rate | Est @ 8.86% | East @ 8.22% | Est @ 7.78% | Est @ 7.47% | Est @ 7.25% | Is 7.1% | Is 6.99% | Is 6.91% | Est @ 6.86% | Est @ 6.83% |
Present value (₹, Millions) discounted @ 19% | 101.5k | 92.2k | 83.3k | 75.1k | ₹ 67.6k | 60.7k | ₹ 54.5k | 48.9k | 43.8k | ₹ 39.3k |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 667b
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. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 6.7%. We discount terminal cash flows to their present value at a cost of equity of 19%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = 227b × (1 + 6.7%) ÷ (19% – 6.7%) = ₹ 1.9t
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= ₹ 1.9t ÷ (1 + 19%)^{ten}= 337b
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is 1.0t. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of 884, the company appears to be roughly at fair value with a discount of 2.2% from the current share price. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
The hypotheses
We draw your attention to the fact that 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 entries, I recommend that you redo the calculations yourself and play with them. 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 full picture of a company’s potential performance. Since we consider Mahindra & Mahindra 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 into account debt. . In this calculation, we used 19%, which is based on a leveraged beta of 2,000. 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 from globally comparable companies, with a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.
To move on :
While important, calculating DCF ideally won’t be the only piece of analysis you’ll look at for a business. DCF models are not the alpha and omega of investment valuation. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. For Mahindra & Mahindra, we’ve put together three essential aspects to explore:
- Risks: For example, we have identified 5 warning signs for Mahindra & Mahindra (2 make us uncomfortable), you should be aware of this.
- Management: Have insiders increased their stocks to take advantage of market sentiment about M & M’s future prospects? Check out our management and board analysis with information on CEO compensation and governance factors.
- Other strong 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 trading fundamentals to see if there are other companies you might not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each NSEI share. If you want to find the calculation for other actions, just search here.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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