Today we will run through one way of estimating the intrinsic value of CorVel Corporation (NASDAQ:CRVL) by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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.
What's the estimated valuation?
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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
|Levered FCF ($, Millions)||US$69.5m||US$73.0m||US$76.1m||US$78.8m||US$81.2m||US$83.4m||US$85.6m||US$87.6m||US$89.6m||US$91.6m|
|Growth Rate Estimate Source||Est @ 6.4%||Est @ 5.1%||Est @ 4.18%||Est @ 3.54%||Est @ 3.09%||Est @ 2.77%||Est @ 2.55%||Est @ 2.4%||Est @ 2.29%||Est @ 2.22%|
|Present Value ($, Millions) Discounted @ 6.3%||US$65.3||US$64.6||US$63.3||US$61.6||US$59.8||US$57.8||US$55.7||US$53.7||US$51.6||US$49.6|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$583m
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 6.3%.
Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$92m× (1 + 2.0%) ÷ (6.3%– 2.0%) = US$2.2b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$2.2b÷ ( 1 + 6.3%)10= US$1.2b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$1.8b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$102, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 CorVel 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 6.3%, which is based on a levered beta of 0.818. 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 is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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. For CorVel, we've put together three pertinent elements you should consider:
- Risks: To that end, you should be aware of the 1 warning sign we've spotted with CorVel .
- Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CRVL's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- 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. 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. 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.
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CorVel Corporation provides workers’ compensation, auto, liability, and health solutions for employers, third party administrators, insurance companies, and government agencies to assist them in managing the medical costs and monitoring the quality of care associated with healthcare claims.
Flawless balance sheet with proven track record.