A Look At The Intrinsic Value Of PCTEL, Inc. (NASDAQ:PCTI)

Today we will run through one way of estimating the intrinsic value of PCTEL, Inc. (NASDAQ:PCTI) 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. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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.

View our latest analysis for PCTEL

Crunching the numbers

We're 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 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

	2021	2022	2023	2024	2025	2026	2027	2028	2029	2030
Levered FCF ($, Millions)	US$6.06m	US$9.03m	US$9.06m	US$9.13m	US$9.23m	US$9.37m	US$9.52m	US$9.68m	US$9.86m	US$10.0m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 0.26%	Est @ 0.79%	Est @ 1.17%	Est @ 1.43%	Est @ 1.61%	Est @ 1.74%	Est @ 1.83%	Est @ 1.89%
Present Value ($, Millions) Discounted @ 6.9%	US$5.7	US$7.9	US$7.4	US$7.0	US$6.6	US$6.3	US$6.0	US$5.7	US$5.4	US$5.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$63m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.0%) 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 6.9%.

Terminal Value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = US$10m× (1 + 2.0%) ÷ (6.9%– 2.0%) = US$210m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$210m÷ ( 1 + 6.9%)¹⁰= US$108m

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$171m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$7.9, the company appears about fair value at a 17% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

The 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 PCTEL 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 6.9%, which is based on a levered beta of 0.933. 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.

Moving On:

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. DCF models are not the be-all and end-all of investment valuation. 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. 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 PCTEL, we've put together three important aspects you should consider:

1. Risks: We feel that you should assess the 3 warning signs for PCTEL (1 is a bit unpleasant!) we've flagged before making an investment in the company.
2. Future Earnings: How does PCTI'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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This article by Simply Wall St is general in nature. 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.
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