RADCOM Ltd.'s (NASDAQ:RDCM) Intrinsic Value Is Potentially 21% Below Its Share Price
Key Insights
Using the 2 Stage Free Cash Flow to Equity, RADCOM fair value estimate is US$8.40
RADCOM's US$10.63 share price signals that it might be 27% overvalued
In this article we are going to estimate the intrinsic value of RADCOM Ltd. (NASDAQ:RDCM) by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
View our latest analysis for RADCOM
Crunching The Numbers
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$6.22m | US$6.68m | US$7.08m | US$7.42m | US$7.71m | US$7.99m | US$8.24m | US$8.48m | US$8.70m | US$8.93m |
Growth Rate Estimate Source | Est @ 9.58% | Est @ 7.39% | Est @ 5.86% | Est @ 4.79% | Est @ 4.04% | Est @ 3.51% | Est @ 3.15% | Est @ 2.89% | Est @ 2.71% | Est @ 2.58% |
Present Value ($, Millions) Discounted @ 7.9% | US$5.8 | US$5.7 | US$5.6 | US$5.5 | US$5.3 | US$5.1 | US$4.8 | US$4.6 | US$4.4 | US$4.2 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$51m
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 7.9%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$8.9m× (1 + 2.3%) ÷ (7.9%– 2.3%) = US$162m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$162m÷ ( 1 + 7.9%)10= US$76m
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$126m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$10.6, the company appears slightly overvalued at the time of writing. 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.
Important 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 RADCOM 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 7.9%, which is based on a levered beta of 1.001. 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 RADCOM
Strength
Currently debt free.
Weakness
Expensive based on P/E ratio and estimated fair value.
Shareholders have been diluted in the past year.
Opportunity
Annual earnings are forecast to grow faster than the American market.
Threat
No apparent threats visible for RDCM.
Next Steps:
Although the valuation of a company is important, it is only one of many factors that you need to assess for 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. Can we work out why the company is trading at a premium to intrinsic value? For RADCOM, we've put together three essential elements you should explore:
Risks: Be aware that RADCOM is showing 1 warning sign in our investment analysis , you should know about...
Future Earnings: How does RDCM'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: 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. 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.
