Estimating The Fair Value Of Q2 Holdings, Inc. (NYSE:QTWO)
Key Insights
Q2 Holdings' estimated fair value is US$37.56 based on 2 Stage Free Cash Flow to Equity
Current share price of US$32.81 suggests Q2 Holdings is potentially trading close to its fair value
Our fair value estimate is 4.1% higher than Q2 Holdings' analyst price target of US$36.07
How far off is Q2 Holdings, Inc. (NYSE:QTWO) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Check out our latest analysis for Q2 Holdings
The Method
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$51.1m | US$84.5m | US$107.7m | US$129.1m | US$147.9m | US$163.9m | US$177.4m | US$188.7m | US$198.3m | US$206.6m |
Growth Rate Estimate Source | Analyst x4 | Analyst x1 | Est @ 27.49% | Est @ 19.88% | Est @ 14.55% | Est @ 10.82% | Est @ 8.20% | Est @ 6.38% | Est @ 5.10% | Est @ 4.20% |
Present Value ($, Millions) Discounted @ 8.9% | US$46.9 | US$71.3 | US$83.5 | US$91.9 | US$96.7 | US$98.4 | US$97.8 | US$95.6 | US$92.2 | US$88.3 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$863m
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 8.9%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$207m× (1 + 2.1%) ÷ (8.9%– 2.1%) = US$3.1b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$3.1b÷ ( 1 + 8.9%)10= US$1.3b
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$2.2b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$32.8, the company appears about fair value at a 13% discount to where the stock price trades currently. 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.
The Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Q2 Holdings 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 8.9%, which is based on a levered beta of 1.139. 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.
Next Steps:
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Q2 Holdings, there are three pertinent aspects you should look at:
Risks: Take risks, for example - Q2 Holdings has 1 warning sign we think you should be aware of.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for QTWO's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
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 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.
