Calculating The Fair Value Of Zhou Liu Fu Jewellery Co., Ltd. (HKG:6168)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Zhou Liu Fu Jewellery fair value estimate is HK$34.07
• Current share price of HK$27.50 suggests Zhou Liu Fu Jewellery is potentially trading close to its fair value
• Peers of Zhou Liu Fu Jewellery are currently trading on average at a 6,038% premium

Does the December share price for Zhou Liu Fu Jewellery Co., Ltd. (HKG:6168) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

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The Method

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (CN¥, Millions)	CN¥319.6m	CN¥381.4m	CN¥436.2m	CN¥483.9m	CN¥524.9m	CN¥560.6m	CN¥591.9m	CN¥620.1m	CN¥646.1m	CN¥670.4m
Growth Rate Estimate Source	Est @ 26.43%	Est @ 19.34%	Est @ 14.39%	Est @ 10.92%	Est @ 8.49%	Est @ 6.79%	Est @ 5.60%	Est @ 4.76%	Est @ 4.18%	Est @ 3.77%
Present Value (CN¥, Millions) Discounted @ 8.8%	CN¥294	CN¥322	CN¥339	CN¥345	CN¥344	CN¥338	CN¥328	CN¥316	CN¥302	CN¥288

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥3.2b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.8%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 8.8%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = CN¥670m× (1 + 2.8%) ÷ (8.8%– 2.8%) = CN¥12b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥12b÷ ( 1 + 8.8%)¹⁰= CN¥4.9b

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 CN¥8.2b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of HK$27.5, the company appears about fair value at a 19% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Zhou Liu Fu Jewellery 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 8.8%, which is based on a levered beta of 1.141. 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.

See our latest analysis for Zhou Liu Fu Jewellery

SWOT Analysis for Zhou Liu Fu Jewellery

Next Steps:

Whilst important, the DCF calculation 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Zhou Liu Fu Jewellery, we've compiled three further aspects you should look at:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Zhou Liu Fu Jewellery (at least 1 which is concerning) , and understanding them should be part of your investment process.
2. Future Earnings: How does 6168'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 Solid Businesses: 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 business fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the SEHK every day. If you want to find the calculation for other stocks 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.