A Look At The Intrinsic Value Of Glaukos Corporation (NYSE:GKOS)

In this article we are going to estimate the intrinsic value of Glaukos Corporation (NYSE:GKOS) by taking the expected future cash flows and discounting them to their present value. I will use the Discounted Cash Flow (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for Glaukos

Step by step through the calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren’t available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 Levered FCF (\$, Millions) US\$18.0m US\$57.0m US\$84.3m US\$113.2m US\$141.3m US\$167.1m US\$189.7m US\$209.3m US\$226.2m US\$240.7m Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ 47.86% Est @ 34.32% Est @ 24.85% Est @ 18.21% Est @ 13.57% Est @ 10.32% Est @ 8.04% Est @ 6.45% Present Value (\$, Millions) Discounted @ 8.2% US\$16.6 US\$48.7 US\$66.6 US\$82.7 US\$95.5 US\$104 US\$110 US\$112 US\$112 US\$110

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US\$857m

The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 10-year government bond rate of 2.7%. We discount the terminal cash flows to today’s value at a cost of equity of 8.2%.

Terminal Value (TV)= FCF2029 × (1 + g) ÷ (r – g) = US\$241m× (1 + 2.7%) ÷ 8.2%– 2.7%) = US\$4.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US\$4.6b÷ ( 1 + 8.2%)10= US\$2.1b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US\$2.9b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US\$63.7, the company appears about fair value at a 6.1% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula – garbage in, garbage out.

Important assumptions

Now 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 evaluation of a company’s future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company’s future capital requirements, so it does not give a full picture of a company’s potential performance. Given that we are looking at Glaukos 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 accounts for debt. In this calculation we’ve used 8.2%, which is based on a levered beta of 0.910. Beta is a measure of a stock’s volatility, compared 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:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to “what assumptions need to be true for this stock to be under/overvalued?” If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Glaukos, I’ve put together three essential factors you should further research:

1. Financial Health: Does GKOS 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 GKOS’s 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 GKOS? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

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