A look at the intrinsic value of Medpace Holdings, Inc. (NASDAQ: MEDP)
Today we are going to take a simple overview of a valuation method used to estimate the attractiveness of Medpace Holdings, Inc. (NASDAQ: MEDP) as an investment opportunity by estimating the flow of future cash flow and discounting them to their present value. We will therefore take advantage of the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too hard to follow, as you will see in our example!
We generally believe that the value of a business is the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. Anyone interested in learning a little more about intrinsic value should have a read of the Simply Wall St.
The method
We use the 2-step growth model, which simply means that we take into account two stages of business growth. During the initial period, the business can have a higher growth rate and the second stage is usually assumed to have a stable growth rate. First, we need to estimate the cash flow of the business over the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or the last reported value. We assume that companies with decreasing free cash flow will slow their withdrawal rate, and companies with increasing free cash flow will see their growth rate slow down during this period. We do this to reflect that growth tends to slow down more in the early years than in the later years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and therefore the sum of these future cash flows is then discounted to present value:
10-year free cash flow (FCF) estimate
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Levered FCF ($, million) | 146.6 million USD | $ 190.9 million | $ 211.1 million | $ 318.0 million | $ 367.0 million | $ 403.1 million | $ 433.3 million | $ 458.7 million | 480.3 million USD | $ 499.1 million |
Source of estimated growth rate | Analyst x2 | Analyst x2 | Analyst x2 | Analyst x1 | Analyst x1 | Is 9.83% | Is 7.49% | Is 5.86% | Is 4.71% | Is 3.91% |
Present value ($, millions) discounted at 6.9% | USD 137 | US $ 167 | $ 173 | US $ 243 | US $ 262 | US $ 270 | US $ 271 | US $ 268 | US $ 263 | $ 255 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = $ 2.3 billion
Now we need to calculate the terminal value, which takes into account all future cash flows after that ten year period. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to their present value at a cost of equity of 6.9%.
Terminal value (TV)= FCF_{2030} Ã— (1 + g) Ã· (r – g) = $ 499 million Ã— (1 + 2.0%) Ã· (6.9% – 2.0%) = $ 10 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= 10 billion USD Ã· (1 + 6.9%)^{ten}= 5.3 billion USD
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is US $ 7.6 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. From the current share price of US $ 191, the company appears to have fair value at a 10% discount from the current share price. Remember though, this is only a rough estimate, and like any complex formula – garbage in, garbage out.
NasdaqGS: MEDP Discounted Cash Flow April 26, 2021
The hypotheses
We draw your attention to the fact that the most important data for a discounted cash flow is the discount rate and, of course, the actual cash flow. You don’t have to agree with these entries, I recommend that you redo the math yourself and play around with it. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we view Medpace Holdings 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 takes into account debt. In this calculation, we used 6.9%, which is based on a leveraged beta of 0.936. Beta is a measure of the volatility of a stock, relative 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.
To move on:
While important, the DCF calculation is just one of the many factors you need to assess for a business. The DCF model is not a perfect inventory valuation tool. Preferably, you would apply different cases and assumptions and see how they would impact the valuation of the business. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. For Medpace Holdings, you need to consider three important factors:
- Risks: Concrete example, we have spotted 2 warning signs for Medpace Holdings you have to be aware of it.
- Management: Have insiders increased their shares to take advantage of market sentiment for MEDP’s future outlook? Check out our management and board analysis with information on CEO compensation and governance factors.
- Other strong companies: Low debt, high returns on equity, and good past performance are essential to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you may not have considered!
PS. Simply Wall St updates its DCF calculation for every US stock every day, so if you want to find the intrinsic value of any other stock just search here.
This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals or your financial situation. We aim to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative information. Simply Wall St has no position in any of the stocks mentioned.
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