How far off is AMN Healthcare Services, Inc. (NYSE:AMN) from its intrinsic value? Using the most recent financial data, we’ll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today’s value. I will be using 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.
Is AMN Healthcare Services fairly valued?
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. 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.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today’s dollars:
10-year free cash flow (FCF) estimate
|Levered FCF ($, Millions)||US$144.7m||US$188.2m||US$206.4m||US$234.5m||US$241.3m||US$247.3m||US$253.3m||US$259.3m||US$265.3m||US$271.4m|
|Growth Rate Estimate Source||Analyst x5||Analyst x6||Analyst x2||Analyst x1||Analyst x1||Est @ 2.5%||Est @ 2.42%||Est @ 2.36%||Est @ 2.32%||Est @ 2.29%|
|Present Value ($, Millions) Discounted @ 7.8%||US$134||US$162||US$165||US$173||US$165||US$157||US$149||US$142||US$135||US$128|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.5b
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 2.2%. We discount the terminal cash flows to today’s value at a cost of equity of 7.8%.
Terminal Value (TV)= FCF2029 × (1 + g) ÷ (r – g) = US$271m× (1 + 2.2%) ÷ 7.8%– 2.2%) = US$4.9b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$4.9b÷ ( 1 + 7.8%)10= US$2.3b
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$3.8b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$49.8, the company appears quite undervalued at a 39% discount to where the stock price trades currently. 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.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 AMN Healthcare Services 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 7.8%, which is based on a levered beta of 0.934. 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.
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. What is the reason for the share price to differ from the intrinsic value? For AMN Healthcare Services, We’ve compiled three further factors you should further research:
- Risks: For example, we’ve discovered 3 warning signs for AMN Healthcare Services that you should be aware of before investing here.
- Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for AMN’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
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.
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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. Thank you for reading.