Stock Analysis

An Intrinsic Calculation For Cogent Communications Holdings, Inc. (NASDAQ:CCOI) Suggests It's 48% Undervalued

  •  Updated
NasdaqGS:CCOI
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Does the March share price for Cogent Communications Holdings, Inc. (NASDAQ:CCOI) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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.

Check out our latest analysis for Cogent Communications Holdings

Step by step through the calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF ($, Millions) US$111.7m US$121.9m US$142.3m US$173.3m US$194.4m US$209.9m US$222.9m US$233.8m US$243.1m US$251.3m
Growth Rate Estimate Source Analyst x8 Analyst x8 Analyst x3 Analyst x2 Analyst x2 Est @ 7.98% Est @ 6.16% Est @ 4.89% Est @ 4% Est @ 3.37%
Present Value ($, Millions) Discounted @ 5.3% US$106 US$110 US$122 US$141 US$150 US$154 US$155 US$155 US$153 US$150

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.4b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 5.3%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$251m× (1 + 1.9%) ÷ (5.3%– 1.9%) = US$7.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$7.6b÷ ( 1 + 5.3%)10= US$4.5b

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$5.9b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$65.6, the company appears quite undervalued at a 48% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
NasdaqGS:CCOI Discounted Cash Flow March 30th 2022

The 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 these result, have a go at the calculation yourself and play with the assumptions. 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 Cogent Communications Holdings 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 5.3%, which is based on a levered beta of 0.800. 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:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for 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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Cogent Communications Holdings, we've compiled three additional aspects you should further examine:

  1. Risks: Take risks, for example - Cogent Communications Holdings has 4 warning signs (and 3 which are potentially serious) we think you should know about.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CCOI'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks just search here.

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