A look at the intrinsic value of California Software Company Limited (NSE: CALSOFT)

Does California Software Company Limited (NSE: CALSOFT) October Share Price Reflect Its True Value? Today, we’re going to estimate the intrinsic value of the stock by estimating the company’s future cash flows and discounting them to their present value. To this end, we will take advantage of the Discounted Cash Flow (DCF) model. Don’t be put off by the lingo, the math is actually pretty straightforward.

Remember, however, that there are many ways to estimate the value of a business, and a DCF is just one method. Anyone who wants to learn a little more about intrinsic value should read the Simply Wall St.

Check out our latest review for California Software

Crunch the numbers

We use the 2-step growth model, which simply means that we take into account two stages of business growth. In the initial period, the business can have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. To begin with, we need to get cash flow estimates for the next ten years. 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) forecast

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 280m

The second stage is also known as terminal value, this is the cash flow of the business after 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 of the 10-year government bond yield of 6.7%. We discount the terminal cash flows to their present value at a cost of equity of 14%.

Terminal value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = ₹ 76m × (1 + 6.7%) ÷ (14% – 6.7%) = ₹ 1.2b

Present value of terminal value (PVTV)= TV / (1 + r)^ten= ₹ 1.2b ÷ (1 + 14%)^ten= ₹ 337m

The total value, or net worth, is then the sum of the present value of the future cash flows, which in this case is 617 million euros. The last step is then to divide the equity value by the number of shares outstanding. From the current share price of 34.3, the company appears to be roughly at fair value with a 14% discount 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 complete picture of a company’s potential performance. Because we view California Software 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 14%, which is based on a leveraged beta of 1.087. 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 an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

To move on :

While important, calculating DCF is just one of the many factors you need to assess for a business. The DCF model is not a perfect equity valuation tool. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For California Software, there are three critical factors you need to explore:

1. Risks: Consider, for example, the ever-present specter of investment risk. We have identified 3 warning signs with California Software (at least 2 that don’t suit us very well), and understanding them should be part of your investment process.
2. 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!
3. Other environmentally friendly companies: Are you concerned about the environment and think that consumers will buy more and more environmentally friendly products? Browse our interactive list of companies thinking about a greener future to discover stocks you may not have thought of!

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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