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A Look At The Intrinsic Value Of Workday, Inc. (NASDAQ:WDAY)

Key Insights

  • The projected fair value for Workday is US$231 based on 2 Stage Free Cash Flow to Equity

  • With US$190 share price, Workday appears to be trading close to its estimated fair value

  • Analyst price target for WDAY is US$212 which is 8.1% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Workday, Inc. (NASDAQ:WDAY) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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.

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See our latest analysis for Workday

The Calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$1.27b

US$1.69b

US$2.11b

US$2.65b

US$3.40b

US$3.91b

US$4.29b

US$4.61b

US$4.87b

US$5.10b

Growth Rate Estimate Source

Analyst x20

Analyst x19

Analyst x19

Analyst x9

Analyst x5

Analyst x4

Est @ 9.63%

Est @ 7.36%

Est @ 5.77%

Est @ 4.66%

Present Value ($, Millions) Discounted @ 8.1%

US$1.2k

US$1.4k

US$1.7k

US$1.9k

US$2.3k

US$2.4k

US$2.5k

US$2.5k

US$2.4k

US$2.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$21b

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 (2.1%) 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 8.1%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$5.1b× (1 + 2.1%) ÷ (8.1%– 2.1%) = US$86b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$86b÷ ( 1 + 8.1%)10= US$39b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$60b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$190, the company appears about fair value at a 18% 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
dcf

Important 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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Workday 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 8.1%, which is based on a levered beta of 1.023. 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 Workday

Strength

  • Debt is not viewed as a risk.

Weakness

  • Shareholders have been diluted in the past year.

Opportunity

  • Forecast to reduce losses next year.

  • Has sufficient cash runway for more than 3 years based on current free cash flows.

  • Good value based on P/S ratio and estimated fair value.

Threat

  • No apparent threats visible for WDAY.

Next Steps:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. 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. For Workday, we've compiled three additional items you should further research:

  1. Risks: Every company has them, and we've spotted 2 warning signs for Workday you should know about.

  2. Future Earnings: How does WDAY'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 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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