This article originally appeared on Simply Wall St News.
The share price of Snap Inc. ( NYSE:SNAP ) rose to yet another new all time high of $83.54 on Friday. The stock price is now up more than 800% in just over 18 months, and 30% since the company released second quarter results two months ago. Some investors may be wondering if the stock price has now run too far, and whether it’s realistic to expect further upside.
The good news for shareholders is that Snap still appears to be trading at a modest discount to its intrinsic value which we calculate in detail below. This calculation is based on analyst forecasts which have been rising consistently since 2018.
Is Snap fairly valued?
To estimate Snap’s fair value, we are using the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Is Snap fairly valued?
We're using the 2-stage growth model, which simply means we take into account two stages of a 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) forecast
Levered FCF ($, Millions)
Growth Rate Estimate Source
Est @ 40.76%
Est @ 29.13%
Est @ 20.99%
Est @ 15.29%
Est @ 11.3%
Est @ 8.51%
Est @ 6.55%
Present Value ($, Millions) Discounted @ 7.1%
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$45b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period.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 7.1%.
Terminal Value (TV) = FCF 2031 × (1 + g) ÷ (r - g) = US$13b× (1 + 2.0%) ÷ (7.1%- 2.0%) = US$252b
Present Value of Terminal Value (PVTV) = TV / (1 + r) 10 = US$252b÷ ( 1 + 7.1%) 10 = US$127b
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$172b.The last step is to then divide the equity value by the number of shares outstanding.Compared to the current share price of US$83.1, the company appearsa touch undervaluedat a 23% discount to where the stock price trades currently.Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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.
Interestingly, the current share prices of other social media stocks like Facebook ( Nasdaq:FB ), Twitter ( NYSE:TWTR ), Pinterest ( NYSE:PINS ), Alphabet ( Nasdaq:GOOG ) are also trading at similar discounts when valued using analyst forecasts. Social media is one industry that analsysts are almost uniformally bullish on.
Snap will be releasing third quarter earnings in about a month's time. When a company is trading at a discount it should provide a margin of safety if earnings are lower than expected - although the company has beaten estimates in 11 of the last 12 quarters. Analysts typically update their earnings forecasts after each quarter’s results are released, which results in our fair value estimate updating too.
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 .
Simply Wall St analyst Richard Bowman and Simply Wall St have no position in any of the companies mentioned. This article 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.