Calculating The Intrinsic Value Of Firstsource Solutions Limited (NSE:FSL)

Key Insights

• The projected fair value for Firstsource Solutions is ₹290 based on 2 Stage Free Cash Flow to Equity
• Firstsource Solutions' ₹305 share price indicates it is trading at similar levels as its fair value estimate
• The ₹406 analyst price target for FSL is 40% more than our estimate of fair value

In this article we are going to estimate the intrinsic value of Firstsource Solutions Limited (NSE:FSL) by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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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What's The Estimated Valuation?

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.

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) estimate

	2026	2027	2028	2029	2030	2031	2032	2033	2034	2035
Levered FCF (₹, Millions)	₹7.82b	₹9.41b	₹10.6b	₹14.0b	₹16.2b	₹18.4b	₹20.5b	₹22.6b	₹24.6b	₹26.7b
Growth Rate Estimate Source	Analyst x9	Analyst x9	Analyst x8	Analyst x1	Est @ 16.16%	Est @ 13.35%	Est @ 11.38%	Est @ 10.00%	Est @ 9.04%	Est @ 8.36%
Present Value (₹, Millions) Discounted @ 13%	₹6.9k	₹7.3k	₹7.2k	₹8.4k	₹8.7k	₹8.6k	₹8.5k	₹8.2k	₹7.9k	₹7.6k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = ₹79b

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 (6.8%) 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 13%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = ₹27b× (1 + 6.8%) ÷ (13%– 6.8%) = ₹429b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= ₹429b÷ ( 1 + 13%)¹⁰= ₹122b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is ₹201b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of ₹305, the company appears around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Firstsource Solutions 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 13%, which is based on a levered beta of 0.890. 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 Firstsource Solutions

SWOT Analysis for Firstsource Solutions

Next Steps:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Firstsource Solutions, we've compiled three relevant elements you should further examine:

1. Risks: As an example, we've found 1 warning sign for Firstsource Solutions that you need to consider before investing here.
2. Future Earnings: How does FSL'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 NSEI every day. If you want to find the calculation for other stocks just search here.

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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.