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. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
5-year cash flow forecast
|Levered FCF ($, Millions)||$16,537.25||$20,802.67||$27,572.26||$34,195.05||$41,680.94|
|Source||Analyst x16||Analyst x14||Analyst x10||Analyst x8||Analyst x8|
|Present Value Discounted @ 11.63%||$14,814.63||$16,694.54||$19,822.36||$22,022.86||$24,047.82|
Present Value of 5-year Cash Flow (PVCF)= $97,402
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 11.6%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = $41,681 × (1 + 2.5%) ÷ (11.6% – 2.5%) = $466,383
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = $466,383 / ( 1 + 11.6%)5 = $269,080
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is $366,482. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of $126.16, which, compared to the current share price of $185.09, we find that Facebook is rather overvalued at the time of writing.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because 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 weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 11.6%, which is based on a levered beta of 1.216. 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.
Although the valuation of a company is important, 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 FB, I’ve put together three fundamental factors you should look at:
- Financial Health: Does FB 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 FB’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 FB? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. Simply Wall St does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.