Starts Corporation Inc.'s (TSE:8850) Intrinsic Value Is Potentially 32% Above Its Share Price

Key Insights

• Starts' estimated fair value is JP¥5,694 based on 2 Stage Free Cash Flow to Equity
• Starts is estimated to be 24% undervalued based on current share price of JP¥4,320
• Peers of Starts are currently trading on average at a 979% premium

Today we will run through one way of estimating the intrinsic value of Starts Corporation Inc. (TSE:8850) by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

AI is about to change healthcare. These 20 stocks are working on everything from early diagnostics to drug discovery. The best part - they are all under $10bn in marketcap - there is still time to get in early.

The Calculation

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable 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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF (¥, Millions)	JP¥20.9b	JP¥10.6b	JP¥17.3b	JP¥16.3b	JP¥18.5b	JP¥18.8b	JP¥19.0b	JP¥19.2b	JP¥19.3b	JP¥19.4b
Growth Rate Estimate Source	Analyst x1	Analyst x1	Analyst x2	Analyst x1	Analyst x1	Analyst x1	Est @ 1.17%	Est @ 0.96%	Est @ 0.80%	Est @ 0.70%
Present Value (¥, Millions) Discounted @ 7.0%	JP¥19.5k	JP¥9.2k	JP¥14.1k	JP¥12.4k	JP¥13.1k	JP¥12.5k	JP¥11.8k	JP¥11.1k	JP¥10.5k	JP¥9.9k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥124b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 0.4%. We discount the terminal cash flows to today's value at a cost of equity of 7.0%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = JP¥19b× (1 + 0.4%) ÷ (7.0%– 0.4%) = JP¥297b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥297b÷ ( 1 + 7.0%)¹⁰= JP¥150b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is JP¥274b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of JP¥4.3k, the company appears a touch undervalued at a 24% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

The Assumptions

Now 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 evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Starts 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 accounts for debt. In this calculation we've used 7.0%, which is based on a levered beta of 1.249. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

View our latest analysis for Starts

SWOT Analysis for Starts

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Can we work out why the company is trading at a discount to intrinsic value? For Starts, we've put together three essential aspects you should explore:

1. Risks: Be aware that Starts is showing 1 warning sign in our investment analysis , you should know about...
2. Future Earnings: How does 8850's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

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

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.