Estimating The Fair Value Of Facebook, Inc. (NASDAQ:FB)

By
Simply Wall St
Published
March 11, 2021
NasdaqGS:FB

Today we will run through one way of estimating the intrinsic value of Facebook, Inc. (NASDAQ:FB) by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!

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

See our latest analysis for Facebook

Crunching the numbers

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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.

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

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF ($, Millions) US$27.3b US$35.7b US$41.5b US$50.4b US$54.7b US$57.9b US$60.7b US$63.0b US$65.2b US$67.1b
Growth Rate Estimate Source Analyst x16 Analyst x14 Analyst x11 Analyst x7 Analyst x5 Est @ 5.89% Est @ 4.74% Est @ 3.93% Est @ 3.36% Est @ 2.96%
Present Value ($, Millions) Discounted @ 7.6% US$25.3k US$30.9k US$33.3k US$37.6k US$37.9k US$37.3k US$36.3k US$35.1k US$33.7k US$32.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$340b

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 7.6%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$67b× (1 + 2.0%) ÷ (7.6%– 2.0%) = US$1.2t

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$1.2t÷ ( 1 + 7.6%)10= US$592b

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$931b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$265, the company appears about fair value at a 19% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
NasdaqGS:FB Discounted Cash Flow March 11th 2021

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Facebook 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 7.6%, which is based on a levered beta of 1.063. 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:

Whilst important, the DCF calculation 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. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Facebook, there are three additional aspects you should further examine:

  1. Risks: To that end, you should be aware of the 1 warning sign we've spotted with Facebook .
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for FB'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. 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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020


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