Healthcare services provider Singapore O&G Ltd (SGX: 41X) is a relatively new stock in Singapore?s market given that its shares began trading only on 4 June 2015.
It?s also been a great stock to own for its investors thus far. Singapore O&G got listed at a share price of S$0.25. Its current share price of S$0.77 thus represents a really strong 208% gain in less than a year.
For some perspective, Singapore?s market barometer, the Straits Times Index (SGX: ^STI), is down by 19% over the same timeframe.
Given such a performance, investors may wonder: Is there more room to run for Singapore…
Healthcare services provider Singapore O&G Ltd (SGX: 41X) is a relatively new stock in Singapore’s market given that its shares began trading only on 4 June 2015.
It’s also been a great stock to own for its investors thus far. Singapore O&G got listed at a share price of S$0.25. Its current share price of S$0.77 thus represents a really strong 208% gain in less than a year.
For some perspective, Singapore’s market barometer, the Straits Times Index (SGX: ^STI), is down by 19% over the same timeframe.
Given such a performance, investors may wonder: Is there more room to run for Singapore O&G? One way to find out would be to try and determine the value of Singapore O&G’s stock. This is where a discounted cash flow (DCF) model enters the fray.
A DCF model essentially sums up all the cash a company can produce over its lifetime before discounting all that cash back into the present.
The popular method of estimating that amount of cash would be to first predict how fast a company can grow its free cash flows over the next 10 years. After which the investor would have to guess how fast the company can grow its free cash flows from the 11th year onward to perpetuity; this growth rate is known as the terminal growth rate.
The thing with a traditional DCF model is that it can be beset with problems. For instance, investors have to project future cash flows – as Yogi Berra once said, “It’s tough to make predictions, especially about the future.”
Investor James Montier touched on this in his book Value Investing: Tools and Techniques for Intelligent Investment when he wrote that traditional DCF models have “problems with estimating cash flows, and problems with estimating the discount rate.”
To circumvent some of these roadblocks, Montier suggested that investors use a reverse-engineered DCF model. Instead of trying to guess what the future will look like, a reverse-engineered DCF model takes a stock’s current price and determines what sort of growth rates the company is expected to achieve with its free cash flow.
Bargain or not
So, let’s use a reverse-engineered DCF model on Singapore O&G. Here are some of the numbers we’d need:
- The company’s current stock price
- The free cash flow per share generated over the last 12 months
- A discount rate
- A terminal growth rate for the company’s free cash flows
As mentioned, Singapore O&G’s stock price is S$0.77 at the moment. Meanwhile, the company has free cash flow per share of 3.04 Singapore cents, according to data from S&P Global Market Intelligence.
The discount rate will be my own required rate of return for the stock (this is also known as the hurdle rate), which I’d set at 15%. It’s worth noting that other versions of the discount rate will incorporate the risk free rate of return, the equity risk premium, and the historical volatility of the stock in question. In my case, I just want to keep things simple.
Coming to the terminal growth rate, we can use the historical rate of inflation in Singapore over the long-term, which runs from 2% to 3%. I’d stick with 3% here.
Here’re the numbers we have so far:
- The company’s current stock price: S$0.77
- The free cash flow per share: S$0.0304
- The discount rate: 15%
- The terminal growth rate for Singapore O&G’s free cash flows: 3%
Using the figures above, my number crunching reveal that the market expects Singapore O&G to grow its free cash flow per share at 25% annually over the next five years, and then at 12.5% per year over the next five year block. This is illustrated in the following table:
Source: Author’s assumptions and calculations
Singapore O&G’s implied growth rates can then be used to compare with our own views on the company’s ability to grow. For some historical perspective, Singapore O&G had grown its annual free cash flows by 66%, 48%, and 34% in 2013, 2014, and 2015, respectively.
If you think that Singapore O&G can grow faster in the future than what’s implied in the table above, then the company could be a bargain now – but if you think the implied growth rates are too ambitious, then Singapore O&G may well be an overpriced stock.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.