I am going to run you through how I calculated the intrinsic value of GreenSky Inc (NASDAQ:GSKY) by taking the foreast future cash flows of the company and discounting them back to today’s value. I will use the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not September 2018 then I highly recommend you check out the latest calculation for GreenSky by following the link below.
What’s the value?
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 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
|Levered FCF ($, Millions)||$210.74||$253.55||$299.19||$350.05||$406.06|
|Source||Analyst x4||Analyst x4||Est @ 18%, capped from 27.02%||Est @ 17%, capped from 27.02%||Est @ 16%, capped from 27.02%|
|Present Value Discounted @ 10.44%||$190.81||$207.86||$222.08||$235.27||$247.10|
Present Value of 5-year Cash Flow (PVCF)= US$1.10b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.9%. We discount this to today’s value at a cost of equity of 10.4%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$406.1m × (1 + 2.9%) ÷ (10.4% – 2.9%) = US$5.58b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$5.58b ÷ ( 1 + 10.4%)5 = US$3.39b
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is US$4.50b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of $24.1. Relative to the current share price of $18.79, the stock is about right, perhaps slightly undervalued at a 22.0% discount to what it is available for right now.
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. You don’t have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at GreenSky 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 I’ve used 10.4%, which is based on a levered beta of 1.063. 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.
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. What is the reason for the share price to differ from the intrinsic value? For GSKY, I’ve put together three key aspects you should further examine:
- Financial Health: Does GSKY 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.
- Future Earnings: How does GSKY’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.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of GSKY? 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.
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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 firstname.lastname@example.org.