The August share price for Stratasys Ltd. (NASDAQ: SSYS) Reflect Its True Value? Today, we’re going to estimate the intrinsic value of the stock by estimating the company’s future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it’s not too hard to follow, as you will see in our example!

There are many ways businesses can be assessed, so we would like to point out that a DCF is not perfect for all situations. If you would like to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St.

Check out our latest review for Stratasys

The calculation

We are going to use a two-step DCF model, which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “steady growth”. To begin with, we need to get cash flow estimates for 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 stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent 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 those future cash flows is then discounted to today’s value. :

10-year Free Cash Flow (FCF) estimate

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 566 million

The second stage is also known as terminal value, this is the cash flow of the business after the first stage. 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 7.2%.

Terminal value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = US $ 104 million × (1 + 2.0%) ÷ (7.2% to 2.0%) = US $ 2.0 billion

Present value of terminal value (PVTV)= TV / (1 + r)^ten= US $ 2.0 billion ÷ (1 + 7.2%)^ten= US $ 1.0 billion

Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is $ 1.6 billion. The last step is then to divide the equity value by the number of shares outstanding. From the current share price of US $ 23.3, the company appears to be roughly at fair value with a 4.2% discount to the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.

Important assumptions

The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. If you don’t agree with these results, try the calculation yourself and play with the assumptions. 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. Because we view Stratasys 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 7.2%, which is based on a leveraged beta of 1.096. 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 from globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Looking forward:

While a business valuation is important, ideally it won’t be the only analysis you review for a business. DCF models are not the alpha and omega of investment valuation. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For Stratasys, we’ve compiled three more factors that you should take a closer look at:

1. Risks: Take risks, for example – Stratasys has 2 warning signs we think you should be aware.
2. Future benefits: How does SSYS ‘growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth expectations chart.
3. Other strong companies: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you might not have considered!

PS. The Simply Wall St app performs a daily discounted cash flow assessment for each NASDAQGS share. If you want to find the calculation for other actions, just search here.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is 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 documents. Simply Wall St has no position in any of the stocks mentioned.
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