EyePoint Pharmaceuticals, Inc.'s (NASDAQ:EYPT) Intrinsic Value Is Potentially 38% Above Its Share Price

Key Insights

• The projected fair value for EyePoint Pharmaceuticals is US$12.22 based on 2 Stage Free Cash Flow to Equity
• EyePoint Pharmaceuticals is estimated to be 27% undervalued based on current share price of US$8.88
• Our fair value estimate is 67% lower than EyePoint Pharmaceuticals' analyst price target of US$36.64

Does the September share price for EyePoint Pharmaceuticals, Inc. (NASDAQ:EYPT) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

View our latest analysis for EyePoint Pharmaceuticals

Is EyePoint Pharmaceuticals Fairly Valued?

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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF ($, Millions)	-US$141.6m	-US$169.0m	-US$148.8m	US$20.8m	US$27.2m	US$33.1m	US$38.5m	US$43.1m	US$47.1m	US$50.5m
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x3	Analyst x3	Est @ 30.36%	Est @ 22.00%	Est @ 16.15%	Est @ 12.06%	Est @ 9.19%	Est @ 7.18%
Present Value ($, Millions) Discounted @ 5.8%	-US$134	-US$151	-US$126	US$16.6	US$20.5	US$23.6	US$25.9	US$27.5	US$28.4	US$28.7

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = -US$239m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 2.5%. We discount the terminal cash flows to today's value at a cost of equity of 5.8%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = US$50m× (1 + 2.5%) ÷ (5.8%– 2.5%) = US$1.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$1.6b÷ ( 1 + 5.8%)¹⁰= US$893m

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$654m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$8.9, the company appears a touch undervalued at a 27% 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

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 EyePoint Pharmaceuticals 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.

SWOT Analysis for EyePoint Pharmaceuticals

Next Steps:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. 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. Can we work out why the company is trading at a discount to intrinsic value? For EyePoint Pharmaceuticals, we've compiled three pertinent factors you should explore:

1. Risks: Be aware that EyePoint Pharmaceuticals is showing 3 warning signs in our investment analysis , and 1 of those is potentially serious...
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for EYPT'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.