Investors In Alliance Data Systems Corporation (NYSE:ADS) Are Paying Above The Intrinsic Value

How far off is Alliance Data Systems Corporation (NYSE:ADS) 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 taking the foreast future cash flows of the company and discounting them back to today's value. I will use the discounted cash flows (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not December 2017 then I highly recommend you check out the latest calculation for Alliance Data Systems by following the link below. See our latest analysis for Alliance Data Systems

Step by step through the calculation

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. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

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 16.4%.

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is $9,969. 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 $180.43, which, compared to the current share price of $239.81, we see that Alliance Data Systems is quite expensive and not available at a discount at this time.

The assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Alliance Data Systems 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 16.4%, which is based on a levered beta of 1.853. 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:

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 ADS, I've compiled three key aspects you should further research:

1. Financial Health: Does ADS 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 ADS'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.

2. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of ADS? 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.

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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.