U.S. markets open in 20 minutes
  • S&P Futures

    4,152.25
    -16.75 (-0.40%)
     
  • Dow Futures

    34,172.00
    -146.00 (-0.43%)
     
  • Nasdaq Futures

    13,311.25
    -75.75 (-0.57%)
     
  • Russell 2000 Futures

    2,208.40
    -14.30 (-0.64%)
     
  • Crude Oil

    65.00
    -0.37 (-0.57%)
     
  • Gold

    1,846.10
    +8.00 (+0.44%)
     
  • Silver

    27.59
    +0.23 (+0.84%)
     
  • EUR/USD

    1.2151
    +0.0004 (+0.04%)
     
  • 10-Yr Bond

    1.6420
    +0.0070 (+0.43%)
     
  • Vix

    20.66
    -2.47 (-10.68%)
     
  • GBP/USD

    1.4107
    +0.0005 (+0.04%)
     
  • USD/JPY

    109.2200
    -0.1270 (-0.12%)
     
  • BTC-USD

    44,849.54
    -3,885.19 (-7.97%)
     
  • CMC Crypto 200

    1,247.71
    -110.85 (-8.16%)
     
  • FTSE 100

    7,007.67
    -35.94 (-0.51%)
     
  • Nikkei 225

    27,824.83
    -259.67 (-0.92%)
     

A Look At The Fair Value Of Silicon Motion Technology Corporation (NASDAQ:SIMO)

  • Oops!
    Something went wrong.
    Please try again later.
Simply Wall St
·6 min read
  • Oops!
    Something went wrong.
    Please try again later.

In this article we are going to estimate the intrinsic value of Silicon Motion Technology Corporation (NASDAQ:SIMO) by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. It may sound complicated, but actually it is quite simple!

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Silicon Motion Technology

Crunching the numbers

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 start off with, we need to estimate 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

Levered FCF ($, Millions)

US$142.2m

US$157.9m

US$169.5m

US$179.2m

US$187.6m

US$194.8m

US$201.3m

US$207.2m

US$212.7m

US$218.0m

Growth Rate Estimate Source

Analyst x4

Analyst x3

Est @ 7.35%

Est @ 5.76%

Est @ 4.64%

Est @ 3.86%

Est @ 3.32%

Est @ 2.93%

Est @ 2.67%

Est @ 2.48%

Present Value ($, Millions) Discounted @ 8.9%

US$131

US$133

US$131

US$127

US$122

US$117

US$111

US$105

US$98.7

US$92.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.2b

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 (2.0%) 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 8.9%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$218m× (1 + 2.0%) ÷ (8.9%– 2.0%) = US$3.2b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$3.2b÷ ( 1 + 8.9%)10= US$1.4b

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$2.5b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$65.7, the company appears about fair value at a 9.3% 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.

dcf
dcf

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 Silicon Motion Technology 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 8.9%, which is based on a levered beta of 1.122. 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.

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Silicon Motion Technology, we've compiled three essential items you should look at:

  1. Risks: We feel that you should assess the 3 warning signs for Silicon Motion Technology we've flagged before making an investment in the company.

  2. Future Earnings: How does SIMO'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 High Quality Alternatives: Do you like a good all-rounder? 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 valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks just search here.

This article by Simply Wall St is general in nature. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.