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Are Investors Undervaluing Datadog, Inc. (NASDAQ:DDOG) By 26%?

Key Insights

  • The projected fair value for Datadog is US$126 based on 2 Stage Free Cash Flow to Equity

  • Current share price of US$93.69 suggests Datadog is potentially 26% undervalued

  • Analyst price target for DDOG is US$98.20 which is 22% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of Datadog, Inc. (NASDAQ:DDOG) by estimating the company's future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Datadog

The Model

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$390.6m

US$545.9m

US$895.2m

US$1.44b

US$2.00b

US$2.44b

US$2.82b

US$3.15b

US$3.43b

US$3.66b

Growth Rate Estimate Source

Analyst x20

Analyst x19

Analyst x5

Analyst x3

Analyst x3

Est @ 21.67%

Est @ 15.80%

Est @ 11.69%

Est @ 8.82%

Est @ 6.81%

Present Value ($, Millions) Discounted @ 8.1%

US$361

US$467

US$708

US$1.1k

US$1.4k

US$1.5k

US$1.6k

US$1.7k

US$1.7k

US$1.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$12b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 8.1%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$3.7b× (1 + 2.1%) ÷ (8.1%– 2.1%) = US$62b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$62b÷ ( 1 + 8.1%)10= US$28b

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$41b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$93.7, the company appears a touch undervalued at a 26% 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.

dcf
dcf

Important Assumptions

Now 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 these result, have a go at the calculation yourself and play with the 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 Datadog 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 8.1%, which is based on a levered beta of 1.013. 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 Datadog

Strength

  • Debt is not viewed as a risk.

Weakness

  • Shareholders have been diluted in the past year.

Opportunity

  • Has sufficient cash runway for more than 3 years based on current free cash flows.

  • Trading below our estimate of fair value by more than 20%.

Threat

  • No apparent threats visible for DDOG.

Moving On:

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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For Datadog, there are three further factors you should look at:

  1. Risks: For example, we've discovered 2 warning signs for Datadog that you should be aware of before investing here.

  2. Future Earnings: How does DDOG'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.

  3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks 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.

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