Schrödinger, Inc.'s (NASDAQ:SDGR) Intrinsic Value Is Potentially 86% Above Its Share Price

Key Insights

• Schrödinger's estimated fair value is US$60.46 based on 2 Stage Free Cash Flow to Equity

• Schrödinger's US$32.50 share price signals that it might be 46% undervalued

• The US$42.20 analyst price target for SDGR is 30% less than our estimate of fair value

In this article we are going to estimate the intrinsic value of Schrödinger, Inc. (NASDAQ:SDGR) by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!

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.

See our latest analysis for Schrödinger

The Model

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	-US$162.6m	-US$61.1m	-US$22.6m	US$39.7m	US$90.3m	US$136.0m	US$185.2m	US$233.3m	US$277.3m	US$315.9m
Growth Rate Estimate Source	Analyst x3	Analyst x3	Analyst x2	Analyst x2	Analyst x2	Est @ 50.67%	Est @ 36.15%	Est @ 25.99%	Est @ 18.88%	Est @ 13.91%
Present Value ($, Millions) Discounted @ 6.7%	-US$152	-US$53.6	-US$18.6	US$30.6	US$65.2	US$92.1	US$118	US$139	US$155	US$165

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$539m

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 6.7%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$316m× (1 + 2.3%) ÷ (6.7%– 2.3%) = US$7.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$7.3b÷ ( 1 + 6.7%)¹⁰= US$3.8b

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$4.4b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$32.5, the company appears quite undervalued at a 46% 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

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Schrödinger 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 6.7%, which is based on a levered beta of 0.961. 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 Schrödinger

Strength

• Currently debt free.

Weakness

• No major weaknesses identified for SDGR.

Opportunity

• Annual revenue is forecast to grow faster than the American market.

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

Threat

• Annual earnings are forecast to decline for the next 4 years.

Next Steps:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or 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. Can we work out why the company is trading at a discount to intrinsic value? For Schrödinger, there are three further elements you should assess:

1. Risks: Take risks, for example - Schrödinger has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

2. Future Earnings: How does SDGR'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. 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.

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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.