Estimating The Intrinsic Value Of Keysight Technologies, Inc. (NYSE:KEYS)

Key Insights

• The projected fair value for Keysight Technologies is US$159 based on 2 Stage Free Cash Flow to Equity
• With US$156 share price, Keysight Technologies appears to be trading close to its estimated fair value
• Our fair value estimate is 3.6% lower than Keysight Technologies' analyst price target of US$165

Today we will run through one way of estimating the intrinsic value of Keysight Technologies, Inc. (NYSE:KEYS) by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Keysight Technologies

What's The Estimated Valuation?

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 begin with, we have to get estimates of 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.

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) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$1.17b	US$1.21b	US$1.42b	US$1.50b	US$1.57b	US$1.63b	US$1.69b	US$1.74b	US$1.79b	US$1.84b
Growth Rate Estimate Source	Analyst x4	Analyst x4	Analyst x3	Est @ 5.60%	Est @ 4.61%	Est @ 3.91%	Est @ 3.43%	Est @ 3.09%	Est @ 2.85%	Est @ 2.68%
Present Value ($, Millions) Discounted @ 7.5%	US$1.1k	US$1.0k	US$1.1k	US$1.1k	US$1.1k	US$1.1k	US$1.0k	US$975	US$933	US$891

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

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 (2.3%) 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 7.5%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$1.8b× (1 + 2.3%) ÷ (7.5%– 2.3%) = US$36b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$36b÷ ( 1 + 7.5%)¹⁰= US$17b

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$28b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$156, the company appears about fair value at a 1.9% 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 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 Keysight Technologies 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 7.5%, which is based on a levered beta of 1.139. 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 Keysight Technologies

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 Keysight Technologies, there are three essential items you should further examine:

1. Risks: To that end, you should be aware of the 1 warning sign we've spotted with Keysight Technologies .
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for KEYS'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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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.