Stock Analysis

Calculating The Fair Value Of salesforce.com, inc. (NYSE:CRM)

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NYSE:CRM
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Today we'll do a simple run through of a valuation method used to estimate the attractiveness of salesforce.com, inc. (NYSE:CRM) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. 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.

See our latest analysis for salesforce.com

Is salesforce.com 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. To begin with, we have to get estimates of 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.

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

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF ($, Millions) US$4.81b US$5.64b US$7.53b US$9.13b US$11.0b US$12.4b US$13.6b US$14.6b US$15.4b US$16.2b
Growth Rate Estimate Source Analyst x29 Analyst x29 Analyst x17 Analyst x7 Analyst x6 Est @ 12.77% Est @ 9.54% Est @ 7.27% Est @ 5.69% Est @ 4.58%
Present Value ($, Millions) Discounted @ 6.6% US$4.5k US$5.0k US$6.2k US$7.1k US$8.0k US$8.5k US$8.7k US$8.8k US$8.7k US$8.5k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$74b

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 6.6%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$16b× (1 + 2.0%) ÷ (6.6%– 2.0%) = US$357b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$357b÷ ( 1 + 6.6%)10= US$188b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$262b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$260, the company appears about fair value at a 2.8% 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
NYSE:CRM Discounted Cash Flow September 17th 2021

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 salesforce.com 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 6.6%, which is based on a levered beta of 0.978. 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.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For salesforce.com, there are three further elements you should explore:

  1. Risks: Be aware that salesforce.com is showing 3 warning signs in our investment analysis , you should know about...
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CRM's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  3. Other High Quality Alternatives: Do you like a good all-rounder? 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 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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