Key Insights

• The projected fair value for AnnAik is S$0.066 based on Dividend Discount Model

• AnnAik's S$0.062 share price indicates it is trading at similar levels as its fair value estimate

• Peers of AnnAik are currently trading on average at a 22% premium

In this article we are going to estimate the intrinsic value of AnnAik Limited (Catalist:A52) by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for AnnAik

The Calculation

We have to calculate the value of AnnAik slightly differently to other stocks because it is a metals and mining 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. The dividend is expected to grow at an annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.1%. We then discount this figure to today's value at a cost of equity of 8.1%. Compared to the current share price of S$0.06, the company appears about fair value at a 5.5% 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)

= S$0.004 / (8.1% – 2.1%)

= S$0.07

The Assumptions

Now 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 result, have a go at the calculation yourself and play with the assumptions. 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 AnnAik 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 8.1%, which is based on a levered beta of 1.325. 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 AnnAik

Strength

• Debt is not viewed as a risk.

• Dividends are covered by earnings and cash flows.

Weakness

• Earnings declined over the past year.

• Dividend is low compared to the top 25% of dividend payers in the Metals and Mining market.

Opportunity

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

• Lack of analyst coverage makes it difficult to determine A52's earnings prospects.

Threat

• No apparent threats visible for A52.

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For AnnAik, there are three relevant elements you should assess:

1. Risks: For example, we've discovered 2 warning signs for AnnAik that you should be aware of before investing here.

2. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

3. Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the CATALIST every day. If you want to find the calculation for other stocks 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.