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I am going to run you through how I calculated the intrinsic value of Computer Programs and Systems, Inc. (NASDAQ:CPSI) by projecting its future cash flows and then discounting them to today’s value. This is done 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 February 2019 then I highly recommend you check out the latest calculation for Computer Programs and Systems by following the link below.
Crunching the numbers
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 begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount this to its value today and sum up the total to get the present value of these cash flows.
5-year cash flow forecast
|Levered FCF ($, Millions)||$38.37||$42.60||$40.50||$41.70||$41.90|
|Source||Analyst x3||Analyst x2||Analyst x1||Analyst x1||Analyst x1|
|Present Value Discounted @ 13.58%||$33.78||$33.02||$27.64||$25.06||$22.17|
Present Value of 5-year Cash Flow (PVCF)= US$142m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.7%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 13.6%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = US$42m × (1 + 2.7%) ÷ (13.6% – 2.7%) = US$397m
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$397m ÷ ( 1 + 13.6%)5 = US$210m
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$352m. 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 $25.85. Compared to the current share price of $33, the stock is fair value, maybe slightly overvalued at the time of writing.
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 Computer Programs and Systems 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 13.6%, which is based on a levered beta of 1.492. 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.
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For CPSI, I’ve compiled three key factors you should further research:
- Financial Health: Does CPSI 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 CPSI’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 CPSI? 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 for every stock on the NASDAQ every 6 hours. If you want to find the calculation for other stocks just search here.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. On rare occasion, data errors may occur. Thank you for reading.