In this article I am going to calculate the intrinsic value of Microchip Technology Incorporated (NASDAQ:MCHP) by estimating the company’s future cash flows and discounting them to their present value. I will be using the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not November 2018 then I highly recommend you check out the latest calculation for Microchip Technology by following the link below.
What’s the value?
I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.
5-year cash flow estimate
|Levered FCF ($, Millions)||$1.37k||$1.66k||$1.86k||$2.18k||$2.53k|
|Source||Analyst x6||Analyst x7||Analyst x1||Est @ 17%, capped from 19.84%||Est @ 16%, capped from 19.84%|
|Present Value Discounted @ 15.21%||$1.19k||$1.25k||$1.22k||$1.24k||$1.25k|
Present Value of 5-year Cash Flow (PVCF)= US$6.1b
After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.9%. We discount this to today’s value at a cost of equity of 15.2%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$2.5b × (1 + 2.9%) ÷ (15.2% – 2.9%) = US$21b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$21b ÷ ( 1 + 15.2%)5 = US$10b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$17b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of $70.26. Relative to the current share price of $75.61, the stock is fair value, maybe slightly overvalued and not available at a discount at this time.
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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Microchip Technology as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 15.2%, which is based on a levered beta of 1.739. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. For MCHP, I’ve compiled three fundamental factors you should further research:
- Financial Health: Does MCHP have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does MCHP’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.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of MCHP? 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 does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
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The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.