Does This Valuation Of Olo Inc. (NYSE:OLO) Imply Investors Are Overpaying?
Key Insights
Olo's estimated fair value is US$4.24 based on 2 Stage Free Cash Flow to Equity
Current share price of US$5.53 suggests Olo is potentially 31% overvalued
Analyst price target for OLO is US$8.50, which is 101% above our fair value estimate
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Olo Inc. (NYSE:OLO) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
View our latest analysis for Olo
Crunching The Numbers
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$5.43m | US$11.3m | US$16.5m | US$21.9m | US$27.1m | US$31.8m | US$35.9m | US$39.3m | US$42.2m | US$44.7m |
Growth Rate Estimate Source | Analyst x3 | Analyst x3 | Est @ 45.92% | Est @ 32.83% | Est @ 23.67% | Est @ 17.25% | Est @ 12.77% | Est @ 9.62% | Est @ 7.42% | Est @ 5.88% |
Present Value ($, Millions) Discounted @ 6.9% | US$5.1 | US$9.9 | US$13.5 | US$16.8 | US$19.4 | US$21.3 | US$22.5 | US$23.0 | US$23.1 | US$22.9 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$178m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.3%) 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 6.9%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$45m× (1 + 2.3%) ÷ (6.9%– 2.3%) = US$991m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$991m÷ ( 1 + 6.9%)10= US$508m
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$686m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$5.5, the company appears potentially overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
Important 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 Olo 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 6.9%, which is based on a levered beta of 1.003. 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 Olo
Strength
Currently debt free.
Weakness
Expensive based on P/S ratio and estimated fair value.
Opportunity
Forecast to reduce losses next year.
Has sufficient cash runway for more than 3 years based on current free cash flows.
Threat
Not expected to become profitable over the next 3 years.
Looking Ahead:
Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value lower than the current share price? For Olo, we've compiled three pertinent elements you should further examine:
Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Olo , and understanding them should be part of your investment process.
Future Earnings: How does OLO'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE 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.
