Is UFP Technologies, Inc. (NASDAQ:UFPT) Trading At A 29% Discount?

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of UFP Technologies, Inc. (NASDAQ:UFPT) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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.

Check out our latest analysis for UFP Technologies

Crunching the numbers

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. 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$26.6m	US$27.2m	US$27.8m	US$28.4m	US$29.0m	US$29.6m	US$30.2m	US$30.8m	US$31.4m	US$32.1m
Growth Rate Estimate Source	Analyst x1	Est @ 2.31%	Est @ 2.21%	Est @ 2.15%	Est @ 2.1%	Est @ 2.07%	Est @ 2.04%	Est @ 2.03%	Est @ 2.02%	Est @ 2.01%
Present Value ($, Millions) Discounted @ 5.8%	US$25.1	US$24.3	US$23.5	US$22.7	US$21.9	US$21.1	US$20.4	US$19.7	US$19.0	US$18.3

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$216m

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 5.8%.

Terminal Value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = US$32m× (1 + 2.0%) ÷ (5.8%– 2.0%) = US$866m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$866m÷ ( 1 + 5.8%)¹⁰= US$494m

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$710m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$66.9, the company appears a touch undervalued at a 29% 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 UFP Technologies 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 5.8%, 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.

Moving On:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For UFP Technologies, there are three relevant aspects you should look at:

1. Risks: For instance, we've identified 2 warning signs for UFP Technologies that you should be aware of.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for UFPT'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 NASDAQCM 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. 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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