Stock Analysis

Fortinet, Inc. (NASDAQ:FTNT) Shares Could Be 41% Below Their Intrinsic Value Estimate

NasdaqGS:FTNT
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Key Insights

  • Fortinet's estimated fair value is US$96.80 based on 2 Stage Free Cash Flow to Equity
  • Fortinet's US$57.31 share price signals that it might be 41% undervalued
  • Our fair value estimate is 36% higher than Fortinet's analyst price target of US$71.10

How far off is Fortinet, Inc. (NASDAQ:FTNT) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Fortinet

Is Fortinet Fairly Valued?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034
Levered FCF ($, Millions) US$2.02b US$2.27b US$2.76b US$3.18b US$3.49b US$3.75b US$3.97b US$4.17b US$4.34b US$4.50b
Growth Rate Estimate Source Analyst x24 Analyst x9 Analyst x3 Analyst x3 Est @ 9.72% Est @ 7.52% Est @ 5.98% Est @ 4.90% Est @ 4.14% Est @ 3.61%
Present Value ($, Millions) Discounted @ 7.0% US$1.9k US$2.0k US$2.3k US$2.4k US$2.5k US$2.5k US$2.5k US$2.4k US$2.4k US$2.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$23b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 7.0%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$4.5b× (1 + 2.4%) ÷ (7.0%– 2.4%) = US$100b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$100b÷ ( 1 + 7.0%)10= US$51b

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$74b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$57.3, the company appears quite good value at a 41% 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.

dcf
NasdaqGS:FTNT Discounted Cash Flow July 26th 2024

The Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 Fortinet 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 7.0%, which is based on a levered beta of 1.002. 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 Fortinet

Strength
  • Earnings growth over the past year exceeded the industry.
  • Debt is well covered by earnings and cashflows.
Weakness
  • Earnings growth over the past year is below its 5-year average.
Opportunity
  • Annual revenue is forecast to grow faster than the American market.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Total liabilities exceed total assets, which raises the risk of financial distress.
  • Annual earnings are forecast to grow slower than the American market.

Moving On:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. 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. Can we work out why the company is trading at a discount to intrinsic value? For Fortinet, there are three additional aspects you should look at:

  1. Risks: Be aware that Fortinet is showing 2 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...
  2. Future Earnings: How does FTNT'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 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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Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.