Calculating The Fair Value Of System1 Group PLC (LON:SYS1)

Key Insights

• System1 Group's estimated fair value is UK£3.90 based on 2 Stage Free Cash Flow to Equity

• Current share price of UK£4.30 suggests System1 Group is potentially trading close to its fair value

• Peers of System1 Group are currently trading on average at a 47% discount

How far off is System1 Group PLC (LON:SYS1) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for System1 Group

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. 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, 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

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (£, Millions)	UK£500.0k	UK£2.10m	UK£2.25m	UK£2.38m	UK£2.48m	UK£2.57m	UK£2.65m	UK£2.71m	UK£2.78m	UK£2.83m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 7.23%	Est @ 5.55%	Est @ 4.38%	Est @ 3.56%	Est @ 2.98%	Est @ 2.58%	Est @ 2.30%	Est @ 2.10%
Present Value (£, Millions) Discounted @ 6.3%	UK£0.5	UK£1.9	UK£1.9	UK£1.9	UK£1.8	UK£1.8	UK£1.7	UK£1.7	UK£1.6	UK£1.5

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£16m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 1.6%. We discount the terminal cash flows to today's value at a cost of equity of 6.3%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = UK£2.8m× (1 + 1.6%) ÷ (6.3%– 1.6%) = UK£61m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= UK£61m÷ ( 1 + 6.3%)¹⁰= UK£33m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£49m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of UK£4.3, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

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 System1 Group 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 6.3%, which is based on a levered beta of 0.855. 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.

SWOT Analysis for System1 Group

Strength

• Currently debt free.

Weakness

• Current share price is above our estimate of fair value.

Opportunity

• Annual revenue is forecast to grow faster than the British market.

Threat

• No apparent threats visible for SYS1.

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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. For System1 Group, there are three essential elements you should explore:

1. Risks: Take risks, for example - System1 Group has 3 warning signs (and 2 which shouldn't be ignored) we think you should know about.

2. Future Earnings: How does SYS1'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the AIM 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.