Stock Analysis

Calculating The Intrinsic Value Of Cognex Corporation (NASDAQ:CGNX)

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NasdaqGS:CGNX
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Today we will run through one way of estimating the intrinsic value of Cognex Corporation (NASDAQ:CGNX) by projecting its future cash flows and then discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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.

View our latest analysis for Cognex

Is Cognex 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 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) estimate

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF ($, Millions) US$311.4m US$364.9m US$424.0m US$467.3m US$503.4m US$533.5m US$558.9m US$580.7m US$600.0m US$617.3m
Growth Rate Estimate Source Analyst x7 Analyst x7 Analyst x1 Est @ 10.21% Est @ 7.72% Est @ 5.98% Est @ 4.76% Est @ 3.91% Est @ 3.31% Est @ 2.89%
Present Value ($, Millions) Discounted @ 6.6% US$292 US$321 US$350 US$361 US$365 US$363 US$356 US$347 US$336 US$324

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$3.4b

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 a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (1.9%) 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 6.6%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$617m× (1 + 1.9%) ÷ (6.6%– 1.9%) = US$13b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$13b÷ ( 1 + 6.6%)10= US$7.0b

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$10b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$65.4, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
NasdaqGS:CGNX Discounted Cash Flow February 9th 2022

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. 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 Cognex 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 1.114. 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.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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. 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 Cognex, there are three fundamental elements you should further examine:

  1. Risks: Be aware that Cognex is showing 2 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 CGNX's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  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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