Is Keysight Technologies, Inc. (NYSE:KEYS) Expensive For A Reason? A Look At Its Intrinsic Value
- Keysight Technologies' estimated fair value is US$142 based on 2 Stage Free Cash Flow to Equity
- Current share price of US$179 suggests Keysight Technologies is 26% overvalued
- Analyst price target for KEYS is US$198 which is 39% above our fair value estimate
In this article we are going to estimate the intrinsic value of Keysight Technologies, Inc. (NYSE:KEYS) by estimating the company's future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
View our latest analysis for Keysight Technologies
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
|Levered FCF ($, Millions)||US$1.18b||US$1.49b||US$1.56b||US$1.68b||US$1.80b||US$1.88b||US$1.95b||US$2.02b||US$2.08b||US$2.14b|
|Growth Rate Estimate Source||Analyst x4||Analyst x3||Analyst x1||Analyst x1||Analyst x1||Est @ 4.78%||Est @ 3.94%||Est @ 3.35%||Est @ 2.94%||Est @ 2.65%|
|Present Value ($, Millions) Discounted @ 8.6%||US$1.1k||US$1.3k||US$1.2k||US$1.2k||US$1.2k||US$1.1k||US$1.1k||US$1.0k||US$986||US$931|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$11b
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 (2.0%) 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 8.6%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$2.1b× (1 + 2.0%) ÷ (8.6%– 2.0%) = US$33b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$33b÷ ( 1 + 8.6%)10= US$14b
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$25b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$179, the company appears slightly overvalued at the time of writing. 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.
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 8.6%, which is based on a levered beta of 1.110. 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
- Earnings growth over the past year exceeded the industry.
- Debt is not viewed as a risk.
- Earnings growth over the past year is below its 5-year average.
- Expensive based on P/E ratio and estimated fair value.
- Annual earnings are forecast to grow for the next 3 years.
- Annual earnings are forecast to grow slower than the American market.
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. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value lower than the current share price? For Keysight Technologies, there are three additional factors you should further research:
- Risks: Be aware that Keysight Technologies is showing 1 warning sign in our investment analysis , you should know about...
- 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.
- 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.
Valuation is complex, but we're helping make it simple.
Find out whether Keysight Technologies is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
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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.
Keysight Technologies, Inc. provides electronic design and test solutions to commercial communications, networking, aerospace, defense and government, automotive, energy, semiconductor, electronic, and education industries in the Americas, Europe, and the Asia Pacific.
Flawless balance sheet with solid track record.