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Is Electronics for Imaging Inc (NASDAQ:EFII) Worth US\$34.02 Based On Intrinsic Value?

Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Electronics for Imaging Inc (NASDAQ:EFII) as an investment opportunity by taking the foreast future cash flows of the company and discounting them back to today’s value. This is done using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. Please also note that this article was written in July 2018 so be sure check out the updated calculation by following the link below.

The calculation

I’m using the 2-stage growth model, 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 perpetual stable growth rate. In the first stage we need to estimate the cash flows to the business over the next five years. Where possible I use analyst estimates, but when these aren’t available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. The sum of these cash flows is then discounted to today’s value.

5-year cash flow estimate

 2018 2019 2020 2021 2022 Levered FCF (\$, Millions) \$59.10 \$82.10 \$89.29 \$97.10 \$105.60 Source Analyst x1 Analyst x2 Extrapolated @ (8.75%) Extrapolated @ (8.75%) Extrapolated @ (8.75%) Present Value Discounted @ 10.57% \$53.45 \$67.16 \$66.05 \$64.97 \$63.90

Present Value of 5-year Cash Flow (PVCF)= US\$315.53m

After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.9%. We discount this to today’s value at a cost of equity of 10.6%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US\$105.60m × (1 + 2.9%) ÷ (10.6% – 2.9%) = US\$1.43b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US\$1.43b ÷ ( 1 + 10.6%)5 = US\$863.59m

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US\$1.18b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of \$26.37. Relative to the current share price of \$34.02, the stock is fair value, maybe slightly overvalued and not available at a discount at this time. NasdaqGS:EFII Intrinsic Value July 12th 18

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Electronics for Imaging 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 10.6%, which is based on a levered beta of 1.081. 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:

Whilst important, DCF calculation 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 EFII, there are three pertinent aspects you should further examine:

1. Financial Health: Does EFII 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 EFII’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: Are there other high quality stocks you could be holding instead of EFII? 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. 