Stock Analysis

# An Intrinsic Calculation For Vicor Corporation (NASDAQ:VICR) Suggests It's 50% Undervalued

In this article we are going to estimate the intrinsic value of Vicor Corporation (NASDAQ:VICR) by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Vicor

## The Method

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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) estimate

 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 Levered FCF (\$, Millions) US\$46.2m US\$66.3m US\$140.7m US\$196.6m US\$252.5m US\$304.2m US\$349.6m US\$388.3m US\$420.6m US\$447.6m Growth Rate Estimate Source Analyst x1 Analyst x1 Analyst x1 Est @ 39.74% Est @ 28.42% Est @ 20.48% Est @ 14.93% Est @ 11.05% Est @ 8.33% Est @ 6.42% Present Value (\$, Millions) Discounted @ 8.3% US\$42.7 US\$56.5 US\$111 US\$143 US\$169 US\$188 US\$200 US\$205 US\$205 US\$202

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US\$1.5b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 8.3%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US\$448m× (1 + 2.0%) ÷ (8.3%– 2.0%) = US\$7.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US\$7.2b÷ ( 1 + 8.3%)10= US\$3.3b

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\$4.8b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US\$54.2, the company appears quite good value at a 50% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

## The Assumptions

Now 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 these inputs, I recommend redoing the calculations yourself and playing with them. 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 Vicor 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 8.3%, which is based on a levered beta of 1.135. 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.

### SWOT Analysis for Vicor

Strength
• Currently debt free.
Weakness
• Earnings declined over the past year.
Opportunity
• Annual earnings are forecast to grow faster than the American market.
• Trading below our estimate of fair value by more than 20%.
Threat
• Revenue is forecast to grow slower than 20% per year.

## Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for 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?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Vicor, we've compiled three important items you should consider:

1. Risks: Take risks, for example - Vicor has 2 warning signs (and 1 which can't be ignored) we think you should know about.
2. Future Earnings: How does VICR'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 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 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.