A Look At The Fair Value Of Utah Medical Products, Inc. (NASDAQ:UTMD)

Key Insights

• Utah Medical Products' estimated fair value is US$86.2 based on 2 Stage Free Cash Flow to Equity
• Current share price of US$90.3 suggests Utah Medical Products is trading close to its fair value
• Industry average of 79% suggests Utah Medical Products' peers are currently trading at a higher premium

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Utah Medical Products, Inc. (NASDAQ:UTMD) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for Utah Medical Products

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. 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.

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) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	US$18.7m	US$18.2m	US$18.0m	US$17.9m	US$18.0m	US$18.2m	US$18.4m	US$18.7m	US$19.0m	US$19.3m
Growth Rate Estimate Source	Est @ -4.48%	Est @ -2.54%	Est @ -1.18%	Est @ -0.23%	Est @ 0.43%	Est @ 0.90%	Est @ 1.22%	Est @ 1.45%	Est @ 1.61%	Est @ 1.72%
Present Value ($, Millions) Discounted @ 7.3%	US$17.4	US$15.8	US$14.6	US$13.6	US$12.7	US$11.9	US$11.3	US$10.7	US$10.1	US$9.6

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$128m

The second stage is also known as Terminal Value, this is the business's cash flow after 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 7.3%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$19m× (1 + 2.0%) ÷ (7.3%– 2.0%) = US$373m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$373m÷ ( 1 + 7.3%)¹⁰= US$185m

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$313m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$90.3, 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.

Important Assumptions

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 Utah Medical Products 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 7.3%, which is based on a levered beta of 0.878. 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.

Next Steps:

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. 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. 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 Utah Medical Products, we've compiled three further elements you should assess:

1. Risks: To that end, you should be aware of the 1 warning sign we've spotted with Utah Medical Products .
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for UTMD's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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.