I am going to run you through how I calculated the intrinsic value of Oracle (NYSE:ORCL) by taking the expected future cash flows and discounted them to the value today. A discounted cash flow (DCF) analysis represents the net present value (NPV) of projected cash flows to a stock. Don’t get put off by the jargon, the math behind it is actually quite straightforward.
If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model.
If you are reading this and its not May 2017 then I highly recommend you check out the latest calculation for Oracle by following the link below. View our latest analysis for Oracle
We are going to use a two stage model that takes into account two stages of growth. The first stage may have a high growth rate and the second stage is usually assumed to have a stable growth rate. In the 1st stage we need to estimate the cash flows to the business over the next 5 years, for this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
Note the numbers here are in millions apart from the per share values.
5-year cash flow estimate
|Levered FCF (USD, Millions)||$11,900.28||$12,296.19||$13,378.65||$13,906.50||$14,981.00|
|Source||Analyst x17||Analyst x19||Analyst x11||Analyst x2||Analyst x2|
|Present Value Discounted @ 11.16%||$10,706.01||$9,952.03||$9,741.45||$9,109.60||$8,828.62|
Present value of next 5 years cash flows: $48,338
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the 5 years. For a number of reasons a very conservative rate is used that cannot exceed that of the GDP. In this case I have used the 10 year government bond rate (2.3%). In the same way as with the 5 year ‘growth’ period we discount this to today’s value.
Terminal Value = FCF2021 × (1 + g) ÷ (Discount Rate – g)
Terminal Value = $14,981 × (1 + 2.3%) ÷ (11.2% – 2.3%)
Terminal value based on the Perpetuity Method where growth (g) = 2.3%: $173,709
Present value of terminal value: $102,370
So the total value is the sum of the next 5 years cash flows and the terminal value discounted to today, this is known as the Equity Value.
Equity Value (Total value) = Present value of next 5 years cash flows + terminal value = $48,338 + $102,370 = $150,708
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.
Value = Total value / Shares Outstanding ($150,707.99 / 4,114.68)
Value per share: $36.63
To finish off with if we compare the intrinsic value of 36.63 to the current share price of $44.17 we find Oracle (NYSE:ORCL) is slightly overvalued and not available at a discount at this time.
I’d like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Oracle as potential investors the Cost of Equity is used as the discount rate, not the Cost of Capital (or Weighed Average Cost of Capital/ WACC) which accounts for debt.
In this calculation I’ve used 11.2% and this is based on a Levered Beta of 1.151. I’m not going to go into how I calculate the Levered Beta in detail, I used the ‘Bottom up Beta’ method based on the comparable businesses, I also impose a limit between 0.8 and 2 which is a reasonable range for a stable business. Google this if you want to learn more.
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. Is Oracle in a healthy financial condition? What is the reason for the share price to differ from the intrinsic value? See our latest FREE analysis to find out!
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.