An Intrinsic Calculation For Alignment Healthcare, Inc. (NASDAQ:ALHC) Suggests It's 26% Undervalued

Key Insights

• Alignment Healthcare's estimated fair value is US$10.15 based on 2 Stage Free Cash Flow to Equity
• Alignment Healthcare is estimated to be 26% undervalued based on current share price of US$7.55
• Our fair value estimate is 19% higher than Alignment Healthcare's analyst price target of US$8.50

How far off is Alignment Healthcare, Inc. (NASDAQ:ALHC) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There's really not all that much to it, even though it might appear quite complex.

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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Alignment Healthcare

What's The Estimated Valuation?

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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	-US$26.0m	US$13.6m	US$27.9m	US$40.5m	US$53.7m	US$66.3m	US$77.6m	US$87.5m	US$95.9m	US$103.0m
Growth Rate Estimate Source	Analyst x1	Analyst x2	Analyst x2	Est @ 45.33%	Est @ 32.45%	Est @ 23.43%	Est @ 17.11%	Est @ 12.69%	Est @ 9.60%	Est @ 7.43%
Present Value ($, Millions) Discounted @ 6.1%	-US$24.5	US$12.0	US$23.4	US$32.0	US$40.0	US$46.6	US$51.4	US$54.6	US$56.5	US$57.2

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$349m

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 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 6.1%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$103m× (1 + 2.4%) ÷ (6.1%– 2.4%) = US$2.9b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$2.9b÷ ( 1 + 6.1%)¹⁰= US$1.6b

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$1.9b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$7.6, the company appears a touch undervalued at a 26% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important Assumptions

We would point out that 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 Alignment Healthcare 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 6.1%, which is based on a levered beta of 0.800. 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 Alignment Healthcare

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize 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?" 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. Can we work out why the company is trading at a discount to intrinsic value? For Alignment Healthcare, there are three essential items you should explore:

1. Risks: As an example, we've found 3 warning signs for Alignment Healthcare that you need to consider before investing here.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for ALHC's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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. 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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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com