- NVIDIA's estimated fair value is US$344 based on 2 Stage Free Cash Flow to Equity
- With US$405 share price, NVIDIA appears to be trading close to its estimated fair value
- Our fair value estimate is 46% lower than NVIDIA's analyst price target of US$641
Does the October share price for NVIDIA Corporation (NASDAQ:NVDA) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
|Levered FCF ($, Millions)||US$23.4b||US$37.4b||US$45.6b||US$49.9b||US$55.5b||US$59.6b||US$63.1b||US$66.1b||US$68.7b||US$71.1b|
|Growth Rate Estimate Source||Analyst x12||Analyst x13||Analyst x9||Analyst x2||Analyst x2||Est @ 7.47%||Est @ 5.87%||Est @ 4.76%||Est @ 3.98%||Est @ 3.43%|
|Present Value ($, Millions) Discounted @ 8.4%||US$21.6k||US$31.8k||US$35.8k||US$36.1k||US$37.0k||US$36.7k||US$35.8k||US$34.6k||US$33.2k||US$31.7k|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$334b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.2%) 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 8.4%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$71b× (1 + 2.2%) ÷ (8.4%– 2.2%) = US$1.2t
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$1.2t÷ ( 1 + 8.4%)10= US$516b
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$850b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$405, the company appears around fair value at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 NVIDIA 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 8.4%, which is based on a levered beta of 1.255. 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 NVIDIA
- Earnings growth over the past year exceeded the industry.
- Debt is not viewed as a risk.
- Dividend is low compared to the top 25% of dividend payers in the Semiconductor market.
- Expensive based on P/E ratio and estimated fair value.
- Annual earnings are forecast to grow faster than the American market.
- No apparent threats visible for NVDA.
Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For NVIDIA, we've compiled three essential aspects you should explore:
- Risks: Take risks, for example - NVIDIA has 1 warning sign we think you should be aware of.
- Future Earnings: How does NVDA'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 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.