How far is Ørsted A/S (CPH:ORSTED) from 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. We will use the Discounted Cash Flow (DCF) model for this purpose. Don’t be put off by the jargon, the underlying calculations are actually quite simple.

We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something that interests you.

Discover our latest analysis for Ørsted

The calculation

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. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or 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.

Generally, 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:

Estimated free cash flow (FCF) over 10 years

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = kr.9.4b

The second stage is also known as the terminal value, it 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 0.1%. We discount terminal cash flows to present value at a cost of equity of 3.6%.

Terminal value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = kr.16b × (1 + 0.1%) ÷ (3.6%– 0.1%) = kr.467b

Present value of terminal value (PVTV)= TV / (1 + r)^ten= kr.467b÷ ( 1 + 3.6%)^ten= kr.328b

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is 337 billion kr. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of 724 kr, the company appears to be about fair value at a discount of 9.7% to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.

The hypotheses

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, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Ørsted 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 debt into account. In this calculation, we used 3.6%, which is based on a leveraged beta of 0.800. 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.

Next steps:

Although the valuation of a business is important, it will ideally not be the only piece of analysis you will look at for a business. DCF models are not the be-all and end-all of investment valuation. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under/overvalued?” If a company grows at a different pace, or if its cost of equity or risk-free rate changes sharply, output may be very different. For Ørsted, we have put together three fundamental factors that you should consider in more detail:

1. Risks: For example, we found 4 warning signs for Ørsted (1 can’t be ignored!) that you need to consider before investing here.
2. Future earnings: How does ORSTED’s growth rate compare to its peers and the wider market? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
3. Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of ​​what you might be missing!

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

Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.

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.