Is IDEXX Laboratories, Inc. (NASDAQ:IDXX) Worth US$427 Based On Its Intrinsic Value?

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, IDEXX Laboratories fair value estimate is US$341
• Current share price of US$427 suggests IDEXX Laboratories is potentially 25% overvalued
• The US$486 analyst price target for IDXX is 42% more than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of IDEXX Laboratories, Inc. (NASDAQ:IDXX) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back 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.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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Crunching The Numbers

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

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF ($, Millions)	US$945.2m	US$1.12b	US$1.18b	US$1.24b	US$1.28b	US$1.33b	US$1.37b	US$1.42b	US$1.46b	US$1.50b
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x3	Est @ 4.36%	Est @ 3.88%	Est @ 3.54%	Est @ 3.30%	Est @ 3.14%	Est @ 3.02%	Est @ 2.94%
Present Value ($, Millions) Discounted @ 6.9%	US$884	US$980	US$968	US$945	US$918	US$889	US$858	US$828	US$798	US$768

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$8.8b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.8%) 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 6.9%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = US$1.5b× (1 + 2.8%) ÷ (6.9%– 2.8%) = US$37b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$37b÷ ( 1 + 6.9%)¹⁰= US$19b

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$28b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$427, the company appears slightly overvalued 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

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 IDEXX Laboratories 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 6.9%, which is based on a levered beta of 0.967. 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.

Check out our latest analysis for IDEXX Laboratories

SWOT Analysis for IDEXX Laboratories

Next Steps:

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. 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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price exceeding the intrinsic value? For IDEXX Laboratories, we've put together three important items you should explore:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with IDEXX Laboratories , and understanding it should be part of your investment process.
2. Future Earnings: How does IDXX'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 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. 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.