A look at the intrinsic value of Art Games Studio SA (WSE:ARG)

What is the distance between Art Games Studio SA (WSE:ARG) and its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by taking expected future cash flows and discounting them to their present value. One way to do this is to use the discounted cash flow (DCF) model. Don’t be put off by the jargon, the underlying calculations are actually quite simple.

We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.

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Is Art Games Studio valued enough?

We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. To start, we need to estimate the cash flows for the next ten years. Since no analyst estimate of free cash flow is available, we have extrapolated the previous free cash flow (FCF) from the company’s latest reported value. 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 more in early years than in later years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we discount the value of these future cash flows to their estimated value in today’s dollars:

10-Year Free Cash Flow (FCF) Forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Leveraged FCF (PLN, Millions) 274,900 zł 400.1k zł 531.1k zł 657.2k zł 771.9k zł zł872.7k 959.7k zł zł1.03m 1.10 zł 1.16 zł
Growth rate estimate Source Is at 63.9% Is at 45.57% East @ 32.73% Is at 23.74% Is at 17.46% Is at 13.05% Is 9.97% Is at 7.81% Is at 6.3% Is at 5.25%
Present value (PLN, millions) discounted at 8.6% 0.3 zł 0.3 zł 0.4 zł 0.5 zł 0.5 zł 0.5 zł 0.5 zł 0.5 zł 0.5 zł 0.5 zł

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = 4.0 million zł

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 stage. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 2.8%. We discount terminal cash flows to present value at a cost of equity of 8.6%.

Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = zł1.2m × (1 + 2.8%) ÷ (8.6%– 2.8%) = zł21m

Present value of terminal value (PVTV)= TV / (1 + r)ten= zł21m÷ ( 1 + 8.6%)ten= zł9.0m

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is zł 13 million. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of 2.0 zł, the company appears approximately at fair value at a 14% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.

WSE: ARG Cash Flow Update November 9, 2022

Important assumptions

We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. 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 complete picture of a company’s potential performance. Since we consider Art Games Studio 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 factors in debt. In this calculation, we used 8.6%, which is based on a leveraged beta of 0.942. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Look forward:

Although important, the DCF calculation is just one of many factors you need to assess for a business. It is not possible to obtain an infallible valuation with a DCF model. Rather, it should be seen as a guide to “what assumptions must 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 have a significant impact on the valuation. For Art Games Studio, there are three fundamental factors you should dig into:

  1. Risks: Every business has them, and we’ve spotted 3 warning signs for Art Games Studio you should know.
  2. Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!
  3. Other environmentally friendly companies: Are you concerned about the environment and do you think that consumers will buy more and more environmentally friendly products? Browse our interactive list of companies thinking about a greener future to discover actions you might not have thought of!

PS. Simply Wall St updates its DCF calculation daily for every Polish stock, so if you want to find the intrinsic value of any other stock, just search here.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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