Calculating The Fair Value Of PDF Solutions, Inc. (NASDAQ:PDFS)
Key Insights
Using the 2 Stage Free Cash Flow to Equity, PDF Solutions fair value estimate is US$34.80
Current share price of US$32.08 suggests PDF Solutions is potentially trading close to its fair value
Analyst price target for PDFS is US$45.00, which is 29% above our fair value estimate
In this article we are going to estimate the intrinsic value of PDF Solutions, Inc. (NASDAQ:PDFS) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
View our latest analysis for PDF Solutions
The Method
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$46.3m | US$58.9m | US$70.5m | US$80.7m | US$89.4m | US$96.7m | US$102.9m | US$108.2m | US$112.8m | US$117.0m |
Growth Rate Estimate Source | Analyst x1 | Est @ 27.18% | Est @ 19.69% | Est @ 14.45% | Est @ 10.78% | Est @ 8.21% | Est @ 6.41% | Est @ 5.16% | Est @ 4.28% | Est @ 3.66% |
Present Value ($, Millions) Discounted @ 8.7% | US$42.6 | US$49.8 | US$54.8 | US$57.7 | US$58.8 | US$58.5 | US$57.2 | US$55.3 | US$53.1 | US$50.6 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$538m
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 (2.2%) 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 8.7%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$117m× (1 + 2.2%) ÷ (8.7%– 2.2%) = US$1.8b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$1.8b÷ ( 1 + 8.7%)10= US$793m
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$1.3b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$32.1, the company appears about fair value at a 7.8% 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.
The 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 PDF Solutions 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 8.7%, which is based on a levered beta of 1.304. 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 PDF Solutions
Strength
Currently debt free.
Weakness
Shareholders have been diluted in the past year.
Opportunity
Annual earnings are forecast to grow faster than the American market.
Current share price is below our estimate of fair value.
Threat
Revenue is forecast to grow slower than 20% per year.
Moving On:
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. 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 PDF Solutions, we've put together three pertinent factors you should further research:
Risks: For instance, we've identified 2 warning signs for PDF Solutions that you should be aware of.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for PDFS's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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!
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.
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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.
