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# Estimating The Fair Value Of MTS Systems Corporation (NASDAQ:MTSC)

Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of MTS Systems Corporation (NASDAQ:MTSC) as an investment opportunity by taking the foreast future cash flows of the company and discounting them back to todayâ€™s value. I will use the discounted cash flows (DCF) model. Donâ€™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. Please also note that this article was written in August 2018 so be sure check out the updated calculation by following the link below.

### Step by step through the calculation

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 â€˜steady growthâ€™ period. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to todayâ€™s value.

#### 5-year cash flow estimate

 2018 2019 2020 2021 2022 Levered FCF (\$, Millions) \$51.75 \$49.33 \$92.28 \$100.67 \$109.82 Source Analyst x2 Analyst x2 Analyst x1 Est @ 9.09% Est @ 9.09% Present Value Discounted @ 10.77% \$46.71 \$40.20 \$67.89 \$66.86 \$65.84

Present Value of 5-year Cash Flow (PVCF)= US\$287.51m

The second stage is also known as Terminal Value, this is the businessâ€™s cash flow after 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 todayâ€™s value at a cost of equity of 10.8%.

Terminal Value (TV) = FCF2022 Ã— (1 + g) Ã· (r â€“ g) = US\$109.82m Ã— (1 + 2.9%) Ã· (10.8% â€“ 2.9%) = US\$1.45b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US\$1.45b Ã· ( 1 + 10.8%)5 = US\$866.52m

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is US\$1.15b. 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 \$64.62. Relative to the current share price of \$51.8, the stock is about right, perhaps slightly undervalued at a 19.83% discount to what it is available for right now.

### Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you donâ€™t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at MTS 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 Iâ€™ve used 10.8%, which is based on a levered beta of 1.11. 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.

### Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldnâ€™t be the only metric you look at when researching a company. For MTSC, Iâ€™ve compiled three relevant factors you should further research:

1. Financial Health: Does MTSC 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.
2. Future Earnings: How does MTSCâ€™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.
3. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of MTSC? 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.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

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 editorial-team@simplywallst.com.