I am going to run you through how I calculated the intrinsic value of Sorrento Therapeutics Inc (NASDAQ:SRNE) using the discounted cash flow (DCF) method. If you want to learn more about this method, the basis for my calculations can be found in detail in the Simply Wall St analysis model. Also note that this article was written in May 2018 so be sure check the latest calculation for Sorrento Therapeutics here.
What’s the value?
We are going to use a two-stage DCF model, which takes into account the initial higher growth stage of a company’s life cycle and the steadier growth phase over the long run. Generally I like to use analyst consensus estimates for free cash flow, but given that SRNE has low analyst coverage with no forecast available, I have extrapolated the most recent reported free cash flow (FCF) based on the average annual revenue growth over the past five years, capped at a reasonable level, and discounted these values at the cost of equity of 5.27%. This resulted in a present value of 5-year cash flow of US$79.86M. Keen to understand how I arrived at this number? Check out our detailed analysis here.
In the visual above, we see how how SRNE’s earnings are expected to move in the future, which should give you an idea of SRNE’s outlook. Then, I determine the terminal value, which accounts for all the future cash flows after the five years. I think it’s suitable to use the 10-year government bond rate of 2.8% as the perpetual growth rate, which is rightly below GDP growth, but more towards the conservative side. After discounting the terminal value back five years, the present value becomes US$864.62M.
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$944.48M. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value of $10.17, which, compared to the current share price of $7.55, we find that Sorrento Therapeutics is about right, perhaps slightly undervalued at a 25.80% discount to what it is available for right now.
Although the valuation of a company is important, it 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 SRNE, I’ve put together three important aspects you should further examine:
- Financial Health: Does SRNE 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 SRNE’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 SRNE? 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 pass 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.