Estimating The Fair Value Of Sage Therapeutics, Inc. (NASDAQ:SAGE)
Key Insights
Sage Therapeutics' estimated fair value is US$29.43 based on 2 Stage Free Cash Flow to Equity
Current share price of US$25.75 suggests Sage Therapeutics is potentially trading close to its fair value
Our fair value estimate is 9.2% higher than Sage Therapeutics' analyst price target of US$26.95
Today we will run through one way of estimating the intrinsic value of Sage Therapeutics, Inc. (NASDAQ:SAGE) by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
View our latest analysis for Sage Therapeutics
The Method
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | -US$233.1m | -US$206.0m | -US$35.9m | US$79.7m | US$89.0m | US$95.9m | US$101.8m | US$106.9m | US$111.3m | US$115.3m |
Growth Rate Estimate Source | Analyst x3 | Analyst x3 | Analyst x2 | Analyst x1 | Analyst x1 | Est @ 7.77% | Est @ 6.13% | Est @ 4.98% | Est @ 4.17% | Est @ 3.61% |
Present Value ($, Millions) Discounted @ 6.1% | -US$220 | -US$183 | -US$30.1 | US$63.0 | US$66.3 | US$67.4 | US$67.4 | US$66.8 | US$65.6 | US$64.1 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$28m
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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 6.1%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$115m× (1 + 2.3%) ÷ (6.1%– 2.3%) = US$3.1b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$3.1b÷ ( 1 + 6.1%)10= US$1.7b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$1.8b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$25.8, the company appears about fair value at a 13% 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 Sage Therapeutics 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 6.1%, which is based on a levered beta of 0.819. 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 Sage Therapeutics
Strength
Currently debt free.
Weakness
No major weaknesses identified for SAGE.
Opportunity
Forecast to reduce losses next year.
Current share price is below our estimate of fair value.
Threat
Has less than 3 years of cash runway based on current free cash flow.
Not expected to become profitable over the next 3 years.
Looking Ahead:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Sage Therapeutics, there are three fundamental items you should explore:
Risks: To that end, you should be aware of the 1 warning sign we've spotted with Sage Therapeutics .
Future Earnings: How does SAGE'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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
