Shareholders in toll road operator Transurban Group (ASX: TCL) have enjoyed stellar returns over the past one, five and ten years.
While the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) has recorded a decline of 6.5%, a gain of 15.3% and a rise of 6.8% over those three time periods respectively, Transurban's share price has rallied 18.1%, 118.5% and 75.6% respectively.
With the share price of Transurban currently trading around the $12 mark, some investors are questioning whether the stock has become over-priced.
While the market is generally more right than wrong when it comes to valuation, individual investors undertaking their own valuation of Transurban need to be aware of some of the key aspects to investing in this $24.5 billion giant.
As an article in the Australian Financial Review recently highlighted, Transurban's key asset – a lease over the Melbourne CityLink – is currently scheduled to end in 2035.
The price you pay matters
Many investors utilise the price-to-earnings (PE) ratio for determining whether a stock is fairly valued, undervalued, or overvalued by comparing it on a relative basis to a peer group or market average.
While in some instances this short-hand valuation technique can provide a roughly accurate answer, arguably it works best for large, established companies with consistent earnings that can be assumed to continue into perpetuity.
In contrast, Transurban's business cannot simply be assumed to continue into perpetuity as all of its operations effectively have an end date.
This makes the vital assumption of perpetuity void!
Rather, a much better way to value Transurban is by utilising a discounted cash flow (DCF) approach over an exclusive time period. It's only through this technique that an investor can, with a reasonable degree of accuracy, value the future cashflows of the group.
