Are Investors Undervaluing Paylocity Holding Corporation (NASDAQ:PCTY) By 47%?
Key Insights
The projected fair value for Paylocity Holding is US$327 based on 2 Stage Free Cash Flow to Equity
Paylocity Holding is estimated to be 47% undervalued based on current share price of US$173
Our fair value estimate is 70% higher than Paylocity Holding's analyst price target of US$193
How far off is Paylocity Holding Corporation (NASDAQ:PCTY) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Check out our latest analysis for Paylocity Holding
Step By Step Through The Calculation
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$288.3m | US$338.9m | US$431.6m | US$583.0m | US$693.0m | US$774.5m | US$843.7m | US$902.2m | US$952.2m | US$995.6m |
Growth Rate Estimate Source | Analyst x12 | Analyst x12 | Analyst x7 | Analyst x1 | Analyst x1 | Est @ 11.77% | Est @ 8.92% | Est @ 6.93% | Est @ 5.54% | Est @ 4.57% |
Present Value ($, Millions) Discounted @ 6.3% | US$271 | US$300 | US$359 | US$457 | US$511 | US$537 | US$550 | US$553 | US$550 | US$541 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$4.6b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.3%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 6.3%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$996m× (1 + 2.3%) ÷ (6.3%– 2.3%) = US$25b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$25b÷ ( 1 + 6.3%)10= US$14b
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$18b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$173, the company appears quite good value at a 47% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
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 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 Paylocity Holding 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 6.3%, which is based on a levered beta of 0.871. 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 Paylocity Holding
Strength
Earnings growth over the past year exceeded the industry.
Currently debt free.
Weakness
No major weaknesses identified for PCTY.
Opportunity
Annual earnings are forecast to grow faster than the American market.
Trading below our estimate of fair value by more than 20%.
Threat
Revenue is forecast to grow slower than 20% per year.
Looking Ahead:
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. 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. Can we work out why the company is trading at a discount to intrinsic value? For Paylocity Holding, we've compiled three further elements you should further examine:
Financial Health: Does PCTY 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 PCTY'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 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. 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.
