CRA International, Inc.’s (NASDAQ:CRAI) Intrinsic Value Is Potentially 23% Below Its Share Price

In this article we are going to estimate the intrinsic value of CRA International, Inc. (NASDAQ:CRAI) by estimating the company’s future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. There’s really not all that much to it, even though it might appear quite complex.

We generally believe that a company’s value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. 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.

See our latest analysis for CRA International

Crunching the numbers

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 ‘steady growth’ period. In the first stage we need to estimate the cash flows to the business over the next ten years. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, 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) forecast

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF ($, Millions) US$11.0m US$14.3m US$16.2m US$17.8m US$19.2m US$20.3m US$21.3m US$22.2m US$22.9m US$23.7m
Growth Rate Estimate Source Analyst x1 Analyst x1 Est @ 13.2% Est @ 9.91% Est @ 7.6% Est @ 5.99% Est @ 4.86% Est @ 4.07% Est @ 3.51% Est @ 3.12%
Present Value ($, Millions) Discounted @ 9.3% US$10.1 US$12.0 US$12.4 US$12.5 US$12.3 US$11.9 US$11.4 US$10.9 US$10.3 US$9.7

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$113m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.2%. We discount the terminal cash flows to today’s value at a cost of equity of 9.3%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$24m× (1 + 2.2%) ÷ (9.3%– 2.2%) = US$341m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$341m÷ ( 1 + 9.3%)10= US$140m

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$253m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$41.9, the company appears slightly overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
NasdaqGS:CRAI Discounted Cash Flow September 6th 2020

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 CRA International 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 9.3%, which is based on a levered beta of 1.179. 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.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. 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. Why is the intrinsic value lower than the current share price? For CRA International, we’ve put together three fundamental items you should consider:

  1. Risks: Take risks, for example – CRA International has 1 warning sign we think you should be aware of.
  2. Future Earnings: How does CRAI’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: Do you like a good all-rounder? 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 updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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