Is There An Opportunity With Palatin Technologies Inc's (NYSEMKT:PTN) 35% Undervaluation?

How far off is Palatin Technologies Inc (AMEX:PTN) from its intrinsic value? Using the most recent financial data, I am going to take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. This is done using the discounted cash flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not April 2018 then I highly recommend you check out the latest calculation for Palatin Technologies by following the link below. View our latest analysis for Palatin Technologies

The method

I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. To begin with we have to get estimates of the next five years of cash flows. Seeing as no analyst estimates of free cash flow are available I have extrapolated the most recent reported free cash flow (FCF) based on the average annual revenue growth over the past five years. The sum of these cash flows is then discounted to today's value.

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 the GDP. In this case I have used the 10-year government bond rate (2.5%). In the same way as with the 5-year 'growth' period, we discount this to today's value at a cost of equity of 11.2%.

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is $432. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of $2.21, which, compared to the current share price of $1.44, we find that Palatin Technologies is quite undervalued at a 34.93% discount to what it is available for right now.

Important assumptions

I'd like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don't have to agree with my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Palatin Technologies as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I've used 11.2%, which is based on a levered beta of 1.159. This is derived from the Bottom-Up Beta method based on 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 shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For PTN, there are three pertinent factors you should further research:

1. Financial Health: Does PTN have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
2. Future Earnings: How does PTN'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: Are there other high quality stocks you could be holding instead of PTN? 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 for every stock on the AMEX every 6 hours. If you want to find the calculation for other stocks just search here.

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article 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.