Roots Corporation (TSE.ROOT) Shares Might Be 44% Lower Than Their Intrinsic Value Estimate

This article will estimate Roots Corporation’s intrinsic value (indicated in the table below).TSE:ROOT() by taking the company’s future cash flows and reducing them to the current value. This will be done by using the Discounted Capital Flow (DCF). Don’t think that you won’t understand it. It’s actually a lot simpler than you think.

Our general belief is that a company’s worth is the value of the future cash it generates. A DCF is only one valuation metric, and it has its flaws. The following article will help you learn more about intrinsic values. Simply Wall St analysis model.

See our latest analysis for Roots

Crunching the Numbers

The 2-stage model is also known as the “2-stage” model. This simply means that we have two periods of cash flow growth. The first stage has higher growth and the second stage has lower growth. First, we need to estimate the cash flows for the next ten-years. If possible, we use analyst estimates. When these are not possible, we extrapolate the previous cash flow (FCF), based on the last estimate or reported value. Companies with decreasing free cash flow will experience a slower rate of shrinkage. However, companies with increasing free cash flow should expect to see a slowing in their growth rate over the same period. This is to show that growth tends slow to the later years more than it does in the early years.

A dollar is generally more valuable today than it will be in the future. To arrive at a present-value estimate, we need to subtract the sum of future cash flows.

10 year free cash flow (FCF estimate)

(“Est”) = FCF growth rate calculated by Simply Wall St
Present Value of 10-year Cash flow (PVCF). = CA$128m

After calculating the future cash flow value over the initial 10-year period, it is necessary to calculate the terminal value, which includes all cash flows beyond that stage. To calculate the Terminal Value, we use the Gordon Growth formula at a future annual rate equal to the average 10-year government bond yield (1.7%). At 11% equity cost, we reduce the terminal cash flows into today’s value.

Terminal Value (TV).= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = CA$23m× (1 + 1.7%) ÷ (11%– 1.7%) = CA$256m

Present Value of Terminal Valu (PVTV).= TV / (1 + R)¹⁰= CA$256m÷ ( 1 + 11%)¹⁰= CA$91m

The equity value or total value is the sum of future cash flows and the present value. In this instance, it is CA$219m. Divide the number of shares outstanding by this figure to get the intrinsic value per share. The company is quite value relative to its current share price of CA$3.0. This represents a 44% discount from the current stock price. This valuation can be affected greatly by the assumptions used in calculations. Therefore, it is better not to get down to the cents.

The Assumptions

We believe that the two most important inputs for a discounted cash flow are the actual cash flows and the discount rate. Try the calculations yourself, and experiment with the assumptions if you aren’t satisfied with the result. The DCF doesn’t take into consideration the possibility of cyclicality in an industry or future capital needs of a company. Therefore, it is not able to give a comprehensive picture of a company’s potential results. Roots are potential shareholders. Therefore, we use the cost-of-equity as the discount rate. This is in contrast to the cost capital (or the weighted average costs of capital, WACC), which accounts for debt. This calculation uses 11% which is based upon a beta of 1.532. Beta measures a stock’s volatility in relation to the overall market. Our beta is determined from the industry’s average beta of globally comparable businesses. There is an imposed limit between 0.8% and 2.0. This is a reasonable range to consider stable businesses.

SWOT Analysis for Roots

Strength

Weakness

Opportunity

Threat

Moving On

Although it is important to evaluate a company’s value, it should not be your only consideration when researching the company. DCF models aren’t the sole way to determine investment value. It should be used as a guideline to determine “what assumptions are necessary for this stock’s under/overvaluation.” The terminal value growth rate can be adjusted to a slight degree, which could dramatically change the overall result. Why is the intrinsic value greater than the current share price We have three other factors that Roots recommends you look at:

1. RisquesConsider, for instance, the ever-present risk of investing. We’ve identified 2 warning signs with Roots Understanding these factors should be part your investment process.

2. Management:Have insiders increased their shares in order to profit from the market’s sentiment about ROOT’s future outlook for ROOT? Take a look at our management and board analysis Get insights on compensation and governance.

3. Other solid businessesA strong business requires low debt, high returns and past performance. Explore! our interactive list of stocks with solid business fundamentals Check out other companies to see if they might be worth your consideration!

PS. Simply Wall St keeps its DCF calculations for all Canadian stocks up-to-date every day. If you’d like to know the intrinsic value of any other stock, just search here.

Let us know what you think about this article. Have a question about the content? Get in touch Contact us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article is by Simply Wall St. It is general in nature. We only provide commentary on historical data and analyst projections. Our articles are not meant to be considered financial advice. It is not a recommendation not to buy or sell any stocks and it doesn’t take into account your financial situation or objectives. We strive to deliver long-term focused analysis that is based on fundamental data. Our analysis may not take into account the most recent price-sensitive company announcements and qualitative material. Simply Wall St does not hold any position in the stocks mentioned.

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