In the following image, we have an example of DCF valuation.
The firm is Servizi Italia S.p.A. The valuation date was August 18, 2016 and the target was 6.06 EURO (plus a range with regard to the fair value, +/-5%). The target was achieved on November 23, 2017 (in this way, the holding period was about one year and 3 months or 462 days, exactly). For this purpose, consult the following link and see the second one image :
The upside was about +73%, with regard to the current market price at the time of the coverage :
[6.06 - 3.50] / 3.50 = + 73.14 %
Let's look at the assumptions of the model :
- The revenues were the proxy of the model : it means that all the variables depended directly on sales as a percentage.
- For the estimation of the revenues of the next three years (2016-2017-2018), I assumed a CAGR of about 3% (the business of the firm is quite steady) ; I looked also at the trend of the past three years.
- For the other items (D&A, NFC, net income, NWC, capex), as I said previously, I assumed a percentage of the revenues : 20%, 1.5%, 5%, 0.5%, 20%. I looked also at the past trend and I considered the evolution of the sector and of the firm, in the next years (for the formula, consult the notes).
- For the estimation of the ERP and tax rate, I used the data source of A. Damodaran (ITA).
- For the risk-free rate, I assumed the weighted average yield of BTP 10 years.
- For the estimation of the beta, I used the regression between FTSE-mib and Servizi Italia with a time frame of 5 years and with monthly returns (I added a spread of 0.10 to consider the additional risk, due to the reduced liquidity of the stock).
- For the cost of debt and for the financial structure, see the notes.
- For the growth rate (g), I assumed a conservative rate of 1% (see the litterature).
- With regard to the calculation of the EV and of the fair value, see the following formula and consult the notes: