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Is Darktrace stock undervalued? DCF calculations suggest so

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Darktrace (LSE:DARK) stock has demonstrated extreme volatility over the past year.

The share price is down 30% over 12 months, but the stock soared in July amid takeover talks before slumping when the talks collapsed a month later.

So, with the stock trading at 285p, is Darktrace really undervalued or is it cheap for a reason?

What it does

The Cambridge-based company sells AI technology that autonomously fights back against cyber attacks in real time.

And it seems like a good time to be in the cybersecurity space. Russia’s invasion of Ukraine and rising geopolitical tensions more broadly have created an environment in which cyber crime (occasionally carried out by organisation backed by nation states) is rife.

In early 2022, US President Joe Biden urged companies to tighten their cyber defences.

Performance

In its last update, Darktrace held its guidance for the year. The firm said that first-quarter revenue rose 37% to $126.3m, while annual recurring revenue rose 40.5% to $511.5m on a constant currency basis. Net new customers rose by a third to 7,757.

This is all very positive. And while there have been concerns about price cutting and falling margins, that doesn’t appear to be showing impacting performance.

Moving forward, Darktrace has forecast 30%-33% revenue growth for 2023, but predicted exchange rates will act as a drag on revenue growth this year.

Attractive valuation

There’s no consensus on the best way to value shares. And with growth stocks it becomes even more complicated.

That’s because forecasting future earnings is a larger part of the equation, and that’s difficult. It raises questions like how long the current growth rate can be sustained, or whether adoption will grow over time.

Today I’m looking at discounted cash flow calculations with a 10-year exit.

Analysts suggest that free cash flow will grow eightfold in 2023 and 2024 before slowing across the next eight years.

Using these figures and a discount rate of around 8%, I reach an equity value of $4.8bn. When divided by the number of shares and compared to the current share price, I can see that the stock is undervalued by 50%.

That’s clearly very attractive, and it certainly raises my interest in the stock.

But it’s important to recognise that forecasting future cash flow is difficult. I’ve used the average forecast from analysts online, but others will vary.

The above calculation suggests a fair share price of 559p. That’s broadly in line with Numis, which recently set a price target of 520p.

So, it does appear that Darktrace is undervalued at this moment in time. That could partially reflect the scandal that impacted the firm in 2022. A founder, Nicole Eagan, was accused of being part of a clique that inflated figures in the sale of Autonomy to Hewlett Packard in 2011.

Despite this, I’m looking to add Darktrace to my portfolio and I’m searching for a good entry point.

The post Is Darktrace stock undervalued? DCF calculations suggest so appeared first on The Motley Fool UK.

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James Fox has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2023