Knowing which valuation model to use for financial analysis can be incredibly confusing for even the most seasoned of investors. A prime example of conflicts between valuation models is Intel Corporation’s (NASDAQ:INTC). While my discounted cash flow (DCF) model tells me that it is overvalued by 19.09%, my relative valuation model says it is undervalued by 10.12%. So, which valuation methodology should I listen to and why?
Check out our latest analysis for Intel
Want to help shape the future of investing tools and platforms? Take the survey and be part of one of the most advanced studies of stock market investors to date.
Examining intrinsic valuation
At the heart of the DCF is the basic assumption that a firm’s intrinsic valuation is equivalent to the sum of all its future free cash flows (FCF). As those familiar with the DCF will know, forecasting FCFs reliably past 5 years is often a difficult and subjective task, which is why I’ve used analyst FCF forecasts as a starting point for my model. When I discount all of INTC’s future FCFs by 12%, I obtain an equity value of $US$185b, then 4.56m shares outstanding are divided through. This results in an intrinsic value of $40.6. Take a look at how I arrived at this intrinsic value here.,
But how dependable is this value? A key assumption in DCFs is that by the final year of our forecast horizon, which is year 5 in INTC’s case, a company is assumed to be mature and therefore FCF should be growing at a sustainable rate. At -6.23%, final year FCF growth is unsustainably low. If this assumption held true, INTC would shrink to a point where it would cease to exist very soon, which is a highly unlikely outcome. To improve our DCF analysis, we could extend the terminal year until FCF growth moderates to a more sustainable level around 1% to 5%. But investors also have to be mindful that there are far less data points the further out we go.
Deep-dive into relative valuation
The basic principle of relative valuation is that two companies with near identical characteristics should be priced similarly. But a big issue here is actually finding companies that are similar to INTC, so I’ve used the Semiconductor industry as a proxy. Obtaining the fair value of INTC through relative valuation is quite straightforward. We simply multiply INTC’s earnings by the industry’s P/E ratio, which gives us a share price of $53.24 that implies INTC is currently undervalued. However, is this conclusion robust enough for us to use?
To check the robustness of our relative valuation, let’s take a look at if INTC has a similar growth profile to the overall Semiconductor industry. With a projected earnings growth rate of 35.04% for next year, INTC has a significantly different growth profile when compared with the Semiconductor industry, which is projected to grow at 18.82%. Unfortunately, this check shows that the Semiconductor industry is a poor proxy for INTC, which weakens our relative valuation analysis. Alternatively, manually selecting companies that shared similar growth profiles with INTC could vastly improve our analysis. I’d encourage you to do this by taking a look at INTC’s competitors.
Which Model Is Superior?
Neither model is perfect despite the robust financial theory behind them. Relative valuation is straightforward but prone to overall market mispricing. Meanwhile, intrinsic valuation is independent from market tendencies; however, is highly exposed to human error. Ultimately, investors should derive their final valuation based off both models. I encourage you to weight each model depending on your preferences to calculate a weighted average target price.
Next Steps:
For INTC, there are three important aspects you should further examine:
- Financial Health: Does INTC 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.
- Future Earnings: How does INTC’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.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of INTC? 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 NASDAQ every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.