Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
Does the February share price for AVROBIO, Inc. (NASDAQ:AVRO) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value by taking the expected future cash flows and discounting them to today’s value. I will be using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not February 2019 then I highly recommend you check out the latest calculation for AVROBIO by following the link below.
I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
5-year cash flow forecast
|Levered FCF ($, Millions)||$-62.60||$-81.95||$-103.97||$19.76||$123.59|
|Source||Analyst x2||Analyst x2||Analyst x2||Analyst x2||Analyst x2|
|Present Value Discounted @ 12.28%||$-55.75||$-65.01||$-73.46||$12.44||$69.26|
Present Value of 5-year Cash Flow (PVCF)= -US$112.5m
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 12.3%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = US$124m × (1 + 2.7%) ÷ (12.3% – 2.7%) = US$1.3b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$1.3b ÷ ( 1 + 12.3%)5 = US$745m
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$633m. The last step is to then 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) then we use the equivalent number. This results in an intrinsic value of $26.61. Compared to the current share price of $14.15, the stock is quite good value at a 47% discount to what it is available for right now.
I’d like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 AVROBIO 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 12.3%, which is based on a levered beta of 1.314. 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.
Whilst important, DCF calculation 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 AVRO, there are three essential factors you should further examine:
- Financial Health: Does AVRO 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 AVRO’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 AVRO? 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 for every stock on the NASDAQ every 6 hours. If you want to find the calculation for other stocks 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 firstname.lastname@example.org.