When looking at a company like salesforce.com, inc. (NYSE:CRM) it is great to put things into perspective by calculating how much is the company worth based on their ability to generate cash flows for investors. We do this by taking the forecast future cash flows of the company and discounting them back to today's value.
The Discounted Cash Flow (DCF) model is the tool we will apply to do this. It may sound complicated, but actually it is quite simple!
Remember, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
Why is This Important
Markets can have extended periods of downturns, and that is when investors would want to know if they have a portion of their portfolio in stable stocks that can withstand high volatility or that can aggressively bounce back after a downturn.
The stocks that can withstand high volatility are called defensive stocks, and they are expected to maintain levels or fall less, in a market downturn. On the flip side, there are the aggressive growth stocks that do great when the economy is booming or when they are on top of a new wave of innovation.
It seems that Salesforce leans closer to an innovator and a growth stock, rather than a defensive play. That is why, we will examine the ability of the stock to regain momentum once the storm settles.
Step by Step Through the Calculation
In our DCF model, we're using the 2-stages, which simply means we take in account two stages of company's growth.
In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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$4.83b||US$5.82b||US$7.49b||US$9.29b||US$11.3b||US$12.8b||US$14.1b||US$15.2b||US$16.1b||US$16.8b|
|Growth Rate Estimate Source||Analyst x29||Analyst x29||Analyst x18||Analyst x8||Analyst x7||Est @ 13.3%||Est @ 9.9%||Est @ 7.5%||Est @ 5.8%||Est @ 4.6%|
|Present Value ($, Millions) Discounted @ 6.2%||US$4.5k||US$5.2k||US$6.2k||US$7.3k||US$8.4k||US$8.9k||US$9.2k||US$9.3k||US$9.3k||US$9.2k|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$78b
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r * g) = US$17b× (1 + 2.0%) ÷ (6.2%* 2.0%) = US$400b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$400b÷ ( 1 + 6.2%)10= US$218b
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$296b.
Relative to the current share price of US$275, the company appears about fair value at a 9.0% discount to where the stock price trades currently.
The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
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.
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.
Conclusion & Looking Ahead:
Our DCF model for Salesforce shows that the company is currently trading around fair value. Salesforce has grown in revenues and is continuing to target more market share via organic growth or acquisitions such as Slack.
In the next phase of their functioning, aside from revenue growth, Salesforce is expected to focus on profitability, which can turn in tho the main value driver for the company.
For salesforce.com, we've put together three important factors you should look at:
- Risks: We feel that you should assess the 3 warning signs for salesforce.com we've flagged before making an investment in the company.
- Future Earnings: How does CRM'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: 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.
Simply Wall St analyst Goran Damchevski 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.
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