Post by Deleted on Dec 24, 2018 16:17:01 GMT
Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of PolarityTE, Inc. (NASDAQ:PTE) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. I will use the Discounted Cash Flows (DCF) model. Donât get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Please also note that this article was written in December 2018 so be sure check out the updated calculation by following the link below.
See our latest analysis for PolarityTE
The model
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second âsteady growthâ period. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.
5-year cash flow forecast
2019 2020 2021 2022 2023
Levered FCF ($, Millions) $-70.00 $-46.00 $-3.00 $40.00 $82.00
Source Analyst x1 Analyst x1 Analyst x1 Analyst x1 Analyst x1
Present Value Discounted @ 12.33% $-62.32 $-36.46 $-2.12 $25.12 $45.85
Present Value of 5-year Cash Flow (PVCF)= -US$29.9m
The second stage is also known as Terminal Value, this is the businessâs cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.9%). In the same way as with the 5-year âgrowthâ period, we discount this to todayâs value at a cost of equity of 12.3%.
Terminal Value (TV) = FCF2022 Ă (1 + g) á (r â g) = US$82m Ă (1 + 2.9%) á (12.3% â 2.9%) = US$900m
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$900m á ( 1 + 12.3%)5 = US$503m
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$473m. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of $22.41. Relative to the current share price of $15.07, the stock is quite undervalued at a 33% discount to what it is available for right now.
<img alt="NasdaqCM:PTE Intrinsic Value Export December 24th 18" class="Maw(100%)" src="https://s.yimg.com/ny/api/res/1.2/CqKyLrYFfEt7xrnzP0Xmzw--~A/YXBwaWQ9aGlnaGxhbmRlcjtzbT0xO3c9ODAw/https://media.zenfs.com/en/simply_wall_st__316/42240fb5438546e567ee4ffd0485de90" itemprop="url"/>
NasdaqCM:PTE Intrinsic Value Export December 24th 18
Important assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you donât agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at PolarityTE as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation Iâve used 12.3%, which is based on a levered beta of 1.33. This is derived from the Bottom-Up Beta method based on 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 shouldnât be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For PTE, Iâve compiled three key factors you should further examine:
Story continues
1. Financial Health: Does PTE have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does PTEâs growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
3. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of PTE? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. Simply Wall St does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
===================================
C L
See our latest analysis for PolarityTE
The model
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second âsteady growthâ period. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.
5-year cash flow forecast
2019 2020 2021 2022 2023
Levered FCF ($, Millions) $-70.00 $-46.00 $-3.00 $40.00 $82.00
Source Analyst x1 Analyst x1 Analyst x1 Analyst x1 Analyst x1
Present Value Discounted @ 12.33% $-62.32 $-36.46 $-2.12 $25.12 $45.85
Present Value of 5-year Cash Flow (PVCF)= -US$29.9m
The second stage is also known as Terminal Value, this is the businessâs cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.9%). In the same way as with the 5-year âgrowthâ period, we discount this to todayâs value at a cost of equity of 12.3%.
Terminal Value (TV) = FCF2022 Ă (1 + g) á (r â g) = US$82m Ă (1 + 2.9%) á (12.3% â 2.9%) = US$900m
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$900m á ( 1 + 12.3%)5 = US$503m
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$473m. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of $22.41. Relative to the current share price of $15.07, the stock is quite undervalued at a 33% discount to what it is available for right now.
<img alt="NasdaqCM:PTE Intrinsic Value Export December 24th 18" class="Maw(100%)" src="https://s.yimg.com/ny/api/res/1.2/CqKyLrYFfEt7xrnzP0Xmzw--~A/YXBwaWQ9aGlnaGxhbmRlcjtzbT0xO3c9ODAw/https://media.zenfs.com/en/simply_wall_st__316/42240fb5438546e567ee4ffd0485de90" itemprop="url"/>
NasdaqCM:PTE Intrinsic Value Export December 24th 18
Important assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you donât agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at PolarityTE as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation Iâve used 12.3%, which is based on a levered beta of 1.33. This is derived from the Bottom-Up Beta method based on 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 shouldnât be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For PTE, Iâve compiled three key factors you should further examine:
Story continues
1. Financial Health: Does PTE have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does PTEâs growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
3. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of PTE? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. Simply Wall St does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
===================================
C L