Today we’re going to do a simple overview of a valuation method used to estimate the attractiveness of BlackLine, Inc. (NASDAQ:BL) as an investment opportunity by taking cash flow expected future of the business and discounting them to today’s value. Our analysis will use the discounted cash flow (DCF) model. Don’t be put off by the jargon, the underlying calculations are actually quite simple.

We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.

The model

We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. To start, we need to estimate the cash flows for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported 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 more in early years than in later years.

Generally, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:

10-Year Free Cash Flow (FCF) Forecast

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $1.2 billion

We now need to calculate the terminal value, which represents all future cash flows after this 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 10-year government bond yield of 1.9%. We discount terminal cash flows to present value at a cost of equity of 7.0%.

Terminal value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$258 million × (1 + 1.9%) ÷ (7.0%–1.9%) = US$5.2 billion

Present value of terminal value (PVTV)= TV / (1 + r)^ten= $5.2 billion ÷ (1 + 7.0%)^ten= $2.7 billion

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is $3.8 billion. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of $64.3, the company appears to be about fair value at a 0.8% discount to the current share price. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.

The hypotheses

We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own 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. Since we view BlackLine 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 factors in debt. In this calculation, we used 7.0%, which is based on a leveraged beta of 1.188. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Look forward:

Valuation is only one side of the coin in terms of building your investment thesis, and it’s just one of many factors you need to assess for a company. It is not possible to obtain an infallible valuation with a DCF model. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under/overvalued?” For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. For BlackLine, we’ve put together three more things you should consider in more detail:

1. Risks: Be aware that BlackLine displays 2 warning signs in our investment analysis you should know…
2. Future earnings: How does BL’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
3. 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 strong trading fundamentals to see if there are any other companies you may not have considered!

PS. The Simply Wall St app performs a daily updated cash flow assessment for each NASDAQGS stock. If you want to find the calculation for other stocks, search here.

Feedback on this article? Concerned about content? Get in touch with us directly. You can also email the editorial team (at) Simplywallst.com.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.