When you look at the analysis page for a particular company, in most cases you will see a fair value for the company’s stock in the Valuation section. Simply Wall St uses discounted cash flow analysis (DCF) to calculate the fair value shown on the app.
For more information on our fair value calculations, please read our article How is fair value calculated.
There are a large number of inputs that go into the fair value calculation including;
- The company’s historical reported financial statement data
- Analyst estimates and forecasts
- Government bond yields and risk free rates
- Share market data such as volatility and equity risk premiums
Whenever any of these inputs change or are updated, the fair value for a company will change too.
You are able to view all of the inputs that have been used for a particular fair value calculation by clicking on the “View Data” button under the fair value infographic.
The fair value has changed several times recently
Some of the inputs that go into the fair value calculation such as bond yields and share market volatility can change on a daily basis. Others such as analyst forecasts will only change when one or more analysts changes their opinion on a stock significantly enough to update their forecasts. As individuals, analysts may not update their numbers for months, but as a group at least one of them may be changing their forecasts up to once a week. On the other end of the spectrum, companies will only report new financial statements once a quarter or even once every half year.
When we look at all of these moving parts, it is understandable that the fair value for a particular stock may change often. However, at Simply Wall St the focus of our analysis is on the long-term picture and not short-term movements, so we will only update some of these inputs on a periodic basis to maintain a stable fair value and smooth out “noisy” fluctuations.
Why did the fair value change so drastically?
Sometimes the fair values for some companies on the app can change by a very large amount in a short amount of time. This can be due to large changes of opinion by analysts, but the more common case is when analysts discontinue coverage or there are few analysts covering the company.
Example: Consider a company called XYZ with 2 analysts covering its business. Analyst A believes that the company will make a $20m profit in 5 years. Analyst B is much less optimistic and believes they will only make a $4m profit. Simply Wall St uses consensus estimates, which is an average of the 2 forecasts or $12m.
Analyst B decides that XYZ is not interesting enough to their clients anymore because its profits aren’t expected to grow much and decide to stop covering the company. This means only the more optimistic Analyst A is left with a forecast and the consensus profit estimate has now increased from $12m to $20m, around 67% higher!
This means within the space of a few days, XYZ’s profit forecasts will have increased by 67% and subsequently, the fair value will also change by a very large amount.
In addition to this, there are also some other factors to do with the sensitivity of inputs into the DCF calculation. Even a very small change to some of the inputs can cause a disproportionately large change in the fair value estimate. There can also be big swings in fair value for companies that have no analyst coverage right after earnings are announced. For companies with no analyst coverage, Simply Wall St will extrapolate historical earnings data into the future. Our analysis normalises profit and cash flow numbers over several years, but If the company has an extremely strong or an extremely weak result one year it can still cause a big change to its fair value.
This is particularly true for the elements that form part of the discount rate calculation. These include risk free rates and equity risk premiums. Fortunately, these tend not to move too far under normal economic conditions, but they can be very volatile when economic conditions are extreme causing very large changes to the fair value estimate.
Large changes in fair value are NOT a buy or sell recommendation
When there is a large increase or decrease to the fair value estimate, it should NOT be used in isolation to make an investment decision. As we highlighted, a large number of inputs go into the calculation and the fair value is highly sensitive to several of these inputs.
Investors should therefore consider the reasons why a change in fair value has occurred and take their own investment objectives into consideration before making a decision.
Our aim is to provide high quality analysis based on the data we have available for any company. We want to empower you with information that can allow you to take informed decisions on your investments.