Calculating The Fair Value Of NetSol Technologies, Inc. (NASDAQ:NTWK)
Key Insights
Using the 2 Stage Free Cash Flow to Equity, NetSol Technologies fair value estimate is US$2.87
With US$2.46 share price, NetSol Technologies appears to be trading close to its estimated fair value
Peers of NetSol Technologies are currently trading on average at a 15% premium
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of NetSol Technologies, Inc. (NASDAQ:NTWK) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.
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. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
Check out our latest analysis for NetSol Technologies
Step By Step Through 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. To start off with, we need to estimate the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Levered FCF ($, Millions) | US$3.96m | US$3.20m | US$2.80m | US$2.56m | US$2.43m | US$2.36m | US$2.32m | US$2.31m | US$2.32m | US$2.34m |
Growth Rate Estimate Source | Est @ -28.13% | Est @ -19.07% | Est @ -12.73% | Est @ -8.29% | Est @ -5.18% | Est @ -3.01% | Est @ -1.48% | Est @ -0.42% | Est @ 0.33% | Est @ 0.85% |
Present Value ($, Millions) Discounted @ 9.0% | US$3.6 | US$2.7 | US$2.2 | US$1.8 | US$1.6 | US$1.4 | US$1.3 | US$1.2 | US$1.1 | US$1.0 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$18m
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. 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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 9.0%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$2.3m× (1 + 2.1%) ÷ (9.0%– 2.1%) = US$34m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$34m÷ ( 1 + 9.0%)10= US$15m
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$32m. 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$2.5, the company appears about fair value at a 14% 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.
Important Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 NetSol 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 9.0%, which is based on a levered beta of 1.167. 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 is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For NetSol Technologies, we've put together three fundamental aspects you should consider:
Risks: Case in point, we've spotted 2 warning signs for NetSol Technologies you should be aware of, and 1 of them makes us a bit uncomfortable.
Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
Other Environmentally-Friendly Companies: Concerned about the environment and think consumers will buy eco-friendly products more and more? Browse through our interactive list of companies that are thinking about a greener future to discover some stocks you may not have thought of!
PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock 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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