Calculating the intrinsic value of SolarEdge Technologies, Inc. (NASDAQ: SEDG)
Does SolarEdge Technologies, Inc. (NASDAQ: SEDG) May Share Price Reflect What It Is Really Worth? 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 therefore take advantage of the Discounted Cash Flow (DCF) model. There really isn’t much to do, although it might seem quite complex.
Remember, however, that there are many ways to estimate the value of a business and that a DCF is just one method. If you want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St.
Crunch the numbers
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”. 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 during this period. We do this to reflect that growth tends to slow down more in the early years than in the later years.
Typically, we assume that a dollar today is worth more than a dollar in the future, and so 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) | $ 239.4 million | $ 273.2 million | $ 433.3 million | $ 562.5 million | $ 683.3 million | $ 790.0 million | 881.2 million USD | $ 957.6 million | $ 1.02 billion | $ 1.08 billion |
Source of estimated growth rate | Analyst x5 | Analyst x6 | Analyst x4 | Is 29.81% | Is 21.47% | Is 15.62% | Is 11.53% | Is 8.67% | Is 6.67% | Is 5.26% |
Present value ($, millions) discounted at 8.3% | US $ 221 | US $ 233 | US $ 341 | US $ 409 | US $ 459 | US $ 490 | US $ 505 | US $ 507 | US $ 499 | US $ 485 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = 4.2 billion USD
The second stage is also known as terminal value, it is the cash flow of the business after the first stage. For a number of reasons, a very conservative growth rate is used that cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 8.3%.
Terminal value (TV)= FCF_{2030} × (1 + g) ÷ (r – g) = $ 1.1 billion × (1 + 2.0%) ÷ (8.3% – 2.0%) = $ 17 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= $ 17 billion ÷ (1 + 8.3%)^{ten}= $ 7.9 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 value of equity, which in this case is $ 12 billion. In the last step, we divide the equity value by the number of shares outstanding. From the current share price of US $ 219, the company appears to have fair value at a 5.2% discount from the current share price. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
NasdaqGS: SEDG Discounted Cash Flow May 6, 2021
The hypotheses
Now the most important data for a discounted cash flow is the discount rate and, of course, the actual 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. Since we view SolarEdge Technologies 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 represents debt. In this calculation, we used 8.3%, which is based on a leveraged beta of 1.164. 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.
Next steps:
Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won’t be the only analysis you look at 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 valuation. For SolarEdge Technologies, we have put together three fundamental elements to consider:
- Risks: Take, for example, the ubiquitous spectrum of investment risk. We have identified 4 warning signs with SolarEdge Technologies, and understanding them should be part of your investment process.
- Management: Have insiders increased their stocks to take advantage of market sentiment for SEDG’s future outlook? Check out our management and board analysis with information on CEO compensation and governance factors.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high quality inventory to get a feel for what you might be missing!
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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