Calculating The Intrinsic Value Of PubMatic, Inc. (NASDAQ:PUBM)
Key Insights
Using the 2 Stage Free Cash Flow to Equity, PubMatic fair value estimate is US$25.23
Current share price of US$23.58 suggests PubMatic is potentially trading close to its fair value
Our fair value estimate is similar to PubMatic's analyst price target of US$25.13
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of PubMatic, Inc. (NASDAQ:PUBM) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
See our latest analysis for PubMatic
The Method
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$53.1m | US$52.8m | US$52.9m | US$53.4m | US$54.1m | US$55.0m | US$56.0m | US$57.1m | US$58.2m | US$59.5m |
Growth Rate Estimate Source | Analyst x2 | Est @ -0.57% | Est @ 0.29% | Est @ 0.89% | Est @ 1.31% | Est @ 1.60% | Est @ 1.81% | Est @ 1.95% | Est @ 2.05% | Est @ 2.12% |
Present Value ($, Millions) Discounted @ 6.2% | US$50.0 | US$46.8 | US$44.2 | US$42.0 | US$40.1 | US$38.4 | US$36.8 | US$35.3 | US$34.0 | US$32.7 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$400m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 6.2%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$59m× (1 + 2.3%) ÷ (6.2%– 2.3%) = US$1.6b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$1.6b÷ ( 1 + 6.2%)10= US$861m
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$1.3b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$23.6, the company appears about fair value at a 6.5% 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 Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 PubMatic 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 6.2%, which is based on a levered beta of 0.844. 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 PubMatic
Strength
Currently debt free.
Weakness
Earnings declined over 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.
Next Steps:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. 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 PubMatic, we've compiled three relevant items you should further examine:
Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with PubMatic , and understanding this should be part of your investment process.
Future Earnings: How does PUBM'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: 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGM every day. If you want to find the calculation for other stocks 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.
