Are TDK Corporation (TSE:6762) Investors Paying Above The Intrinsic Value?

Key Insights

• The projected fair value for TDK is JP¥1,816 based on 2 Stage Free Cash Flow to Equity
• Current share price of JP¥2,197 suggests TDK is potentially 21% overvalued
• Analyst price target for 6762 is JP¥2,606, which is 43% above our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of TDK Corporation (TSE:6762) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

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Is TDK Fairly Valued?

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. To start off with, we need to estimate the next ten years of cash flows. 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)	JP¥81.3b	JP¥121.2b	JP¥149.5b	JP¥170.0b	JP¥198.0b	JP¥217.8b	JP¥233.4b	JP¥245.5b	JP¥254.9b	JP¥262.2b
Growth Rate Estimate Source	Analyst x7	Analyst x7	Analyst x6	Analyst x1	Analyst x1	Est @ 9.99%	Est @ 7.17%	Est @ 5.20%	Est @ 3.82%	Est @ 2.85%
Present Value (¥, Millions) Discounted @ 6.9%	JP¥76.1k	JP¥106.1k	JP¥122.4k	JP¥130.3k	JP¥142.0k	JP¥146.1k	JP¥146.5k	JP¥144.2k	JP¥140.0k	JP¥134.8k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = JP¥1.3t

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 0.6%. We discount the terminal cash flows to today's value at a cost of equity of 6.9%.

Terminal Value (TV)= FCF₂₀₃₅ × (1 + g) ÷ (r – g) = JP¥262b× (1 + 0.6%) ÷ (6.9%– 0.6%) = JP¥4.2t

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= JP¥4.2t÷ ( 1 + 6.9%)¹⁰= JP¥2.2t

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¥3.4t. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of JP¥2.2k, the company appears slightly overvalued 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. 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 TDK 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 6.9%, which is based on a levered beta of 1.196. 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.

Check out our latest analysis for TDK

SWOT Analysis for TDK

Next Steps:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. Why is the intrinsic value lower than the current share price? For TDK, we've compiled three relevant elements you should explore:

1. Risks: For example, we've discovered 1 warning sign for TDK that you should be aware of before investing here.
2. Future Earnings: How does 6762'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.

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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.