A Look At The Fair Value Of Applied Materials, Inc. (NASDAQ:AMAT)




  • In Business
  • 2020-09-13 13:26:35Z
  • By Simply Wall St.
A Look At The Fair Value Of Applied Materials, Inc. (NASDAQ:AMAT)
A Look At The Fair Value Of Applied Materials, Inc. (NASDAQ:AMAT)  

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Applied Materials, Inc. (NASDAQ:AMAT) as an investment opportunity by estimating the company's future cash flows and discounting them to their present 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!

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.

View our latest analysis for Applied Materials

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. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

Levered FCF ($, Millions)

US$4.08b

US$4.33b

US$4.23b

US$4.57b

US$4.70b

US$4.82b

US$4.95b

US$5.07b

US$5.19b

US$5.31b

Growth Rate Estimate Source

Analyst x9

Analyst x6

Analyst x1

Analyst x1

Est @ 2.87%

Est @ 2.67%

Est @ 2.54%

Est @ 2.44%

Est @ 2.38%

Est @ 2.33%

Present Value ($, Millions) Discounted @ 9.4%

US$3.7k

US$3.6k

US$3.2k

US$3.2k

US$3.0k

US$2.8k

US$2.6k

US$2.5k

US$2.3k

US$2.2k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$29b

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 (2.2%) 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 9.4%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r - g) = US$5.3b× (1 + 2.2%) ÷ (9.4%- 2.2%) = US$76b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$76b÷ ( 1 + 9.4%)10= US$31b

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$60b. 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$55.0, the company appears about fair value at a 16% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

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 Applied Materials 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 9.4%, which is based on a levered beta of 1.195. 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.

Moving On:

Whilst important, the DCF calculation 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?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Applied Materials, we've put together three essential elements you should consider:

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

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for AMAT's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

  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.

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@simplywallst.com.

COMMENTS

More Related News

Should You Buy Andrew Peller Limited (TSE:ADW.A) For Its Upcoming Dividend?
Should You Buy Andrew Peller Limited (TSE:ADW.A) For Its Upcoming Dividend?

Readers hoping to buy Andrew Peller Limited (TSE:ADW.A) for its dividend will need to make their move shortly, as the...

ZAGG Inc
ZAGG Inc's (NASDAQ:ZAGG) Intrinsic Value Is Potentially 92% Above Its Share Price

Does the September share price for ZAGG Inc (NASDAQ:ZAGG) reflect what it's really worth? Today, we will estimate the...

We
We're Hopeful That Strike Energy (ASX:STX) Will Use Its Cash Wisely

Just because a business does not make any money, does not mean that the stock will go down. For example, biotech and...

Are Investors Undervaluing Starpharma Holdings Limited (ASX:SPL) By 39%?
Are Investors Undervaluing Starpharma Holdings Limited (ASX:SPL) By 39%?

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Starpharma Holdings...

Here
Here's Why We're Not Too Worried About Vista Gold's (NYSEMKT:VGZ) Cash Burn Situation

Just because a business does not make any money, does not mean that the stock will go down. For example, although...

Leave a Comment

Your email address will not be published. Required fields are marked with *

Cancel reply

Comments

Top News: Business