Stock Analysis

Estimating The Intrinsic Value Of PagerDuty, Inc. (NYSE:PD)

NYSE:PD
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Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, PagerDuty fair value estimate is US$36.65
  • Current share price of US$33.84 suggests PagerDuty is potentially trading close to its fair value
  • Analyst price target for PD is US$34.21 which is 6.7% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of PagerDuty, Inc. (NYSE:PD) by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There's really not all that much to it, even though it might appear quite complex.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

Check out our latest analysis for PagerDuty

Crunching The Numbers

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF ($, Millions) US$733.8k US$51.5m US$81.2m US$130.0m US$169.5m US$206.7m US$239.7m US$267.9m US$291.7m US$311.7m
Growth Rate Estimate Source Analyst x6 Analyst x5 Analyst x5 Analyst x1 Est @ 30.42% Est @ 21.91% Est @ 15.96% Est @ 11.79% Est @ 8.88% Est @ 6.83%
Present Value ($, Millions) Discounted @ 8.2% US$0.7 US$43.9 US$64.0 US$94.7 US$114 US$129 US$138 US$142 US$143 US$141

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.0b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.1%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 8.2%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$312m× (1 + 2.1%) ÷ (8.2%– 2.1%) = US$5.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$5.2b÷ ( 1 + 8.2%)10= US$2.3b

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$3.3b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$33.8, the company appears about fair value at a 7.7% 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.

dcf
NYSE:PD Discounted Cash Flow April 5th 2023

Important 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 PagerDuty 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 8.2%, which is based on a levered beta of 1.038. 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 PagerDuty

Strength
  • Cash in surplus of total debt.
Weakness
  • Shareholders have been diluted in the past year.
Opportunity
  • Forecast to reduce losses next year.
  • Has sufficient cash runway for more than 3 years based on current free cash flows.
  • Current share price is below our estimate of fair value.
Threat
  • Debt is not well covered by operating cash flow.
  • Not expected to become profitable over the next 3 years.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" 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. For PagerDuty, there are three essential aspects you should further examine:

  1. Risks: Every company has them, and we've spotted 2 warning signs for PagerDuty you should know about.
  2. Future Earnings: How does PD'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 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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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.