Investors Are Undervaluing ADT Inc. (NYSE:ADT) By 41.65%
I am going to run you through how I calculated the intrinsic value of ADT Inc. (NYSE:ADT) by projecting its future cash flows and then discounting them to today’s value. This is done using the discounted cash flows (DCF) model. Don’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. If you are reading this and its not January 2019 then I highly recommend you check out the latest calculation for ADT by following the link below.
View our latest analysis for ADT
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The model
I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. To begin with we have to get estimates of 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 today’s value.
5-year cash flow estimate
2019 | 2020 | 2021 | 2022 | 2023 | |
Levered FCF ($, Millions) | $675.03 | $878.43 | $1.04k | $1.21k | $1.41k |
Source | Analyst x3 | Analyst x3 | Est @ 18%, capped from 38.11% | Est @ 17%, capped from 38.11% | Est @ 16%, capped from 38.11% |
Present Value Discounted @ 14.83% | $587.85 | $666.18 | $684.56 | $697.50 | $704.60 |
Present Value of 5-year Cash Flow (PVCF)= US$3.3b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.7%. We discount this to today’s value at a cost of equity of 14.8%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = US$1.4b × (1 + 2.7%) ÷ (14.8% – 2.7%) = US$12b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$12b ÷ ( 1 + 14.8%)5 = US$6.0b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$9.3b. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of $12.32. Compared to the current share price of $7.19, the stock is quite good value at a 42% discount to what it is available for right now.
The 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 don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at ADT 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 I’ve used 14.8%, which is based on a levered beta of 1.664. 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 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 ADT, I’ve put together three key factors you should further research:
Financial Health: Does ADT 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 ADT’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 ADT? 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.
