# Calculating The Intrinsic Value Of Scientific Games Corporation (NASDAQ:SGMS)

By
Simply Wall St
Published
January 03, 2022

In this article we are going to estimate the intrinsic value of Scientific Games Corporation (NASDAQ:SGMS) by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. 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.

Check out our latest analysis for Scientific Games

### 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

#### 10-year free cash flow (FCF) forecast

 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 Levered FCF (\$, Millions) US\$233.0m US\$451.9m US\$481.7m US\$506.8m US\$528.3m US\$547.1m US\$563.9m US\$579.4m US\$593.9m US\$607.8m Growth Rate Estimate Source Analyst x4 Analyst x5 Est @ 6.6% Est @ 5.21% Est @ 4.24% Est @ 3.55% Est @ 3.07% Est @ 2.74% Est @ 2.51% Est @ 2.34% Present Value (\$, Millions) Discounted @ 10% US\$211 US\$371 US\$358 US\$341 US\$322 US\$302 US\$282 US\$262 US\$244 US\$226

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US\$2.9b

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 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 10%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US\$608m× (1 + 2.0%) ÷ (10%– 2.0%) = US\$7.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US\$7.3b÷ ( 1 + 10%)10= US\$2.7b

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\$5.6b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US\$66.8, the company appears around fair value at the time of writing. 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.

### Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Scientific Games 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 10%, which is based on a levered beta of 1.930. 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.

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Scientific Games, there are three important factors you should further examine:

1. Risks: We feel that you should assess the 4 warning signs for Scientific Games (2 can't be ignored!) we've flagged before making an investment in the company.
2. Future Earnings: How does SGMS'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks just search here.

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