In this article, we will estimate the intrinsic value of Science Applications International Corporation (NYSE:SAIC) by taking the company’s expected future cash flows and discounting them to present value. Our analysis will use the discounted cash flow (DCF) model. This may sound complicated, but it’s actually quite simple!
We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St Analysis Template.
Check out our latest analysis for Science Applications International
Is Science Applications International valued at its fair value?
We use what is called a 2-stage model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. To start, we need to estimate the cash flows for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.
A DCF is based on the idea that a dollar in the future is worth less 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) Forecast
|Leveraged FCF ($, millions)||$459.6 million||$509.5 million||$560.8 million||$540.0 million||$530.0 million||$526.2 million||$526.6 million||$529.9 million||$535.3 million||$542.2 million|
|Growth rate estimate Source||Analyst x5||Analyst x5||Analyst x4||Analyst x2||Is @ -1.85%||Is @ -0.72%||Is at 0.07%||Is at 0.63%||Is at 1.02%||Is at 1.29%|
|Present value (in millions of dollars) discounted at 6.7%||$431||$448||$462||$417||$384||$357||$335||$316||$299||$284|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $3.7 billion
The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (1.9%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 6.7%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$542 million × (1 + 1.9%) ÷ (6.7%–1.9%) = US$12 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= $12 billion ÷ (1 + 6.7%)ten= $6.1 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $9.8 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of US$90.8, the company appears to be pretty good value at a 48% discount to the current share price. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.
We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play around with them. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Science Applications International 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 takes debt into account. In this calculation, we used 6.7%, which is based on a leveraged beta of 1.121. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
While a business valuation is important, it shouldn’t be the only metric to consider when researching a business. The DCF model is not a perfect stock valuation tool. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. Why is intrinsic value higher than the current stock price? For Science Applications International, we’ve put together three relevant things you should dig into:
- Risks: Take risks, for example – Science Applications International a 3 warning signs we think you should know.
- Future earnings: How does SAIC’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
PS. Simply Wall St updates its DCF calculation for every US stock daily, so if you want to find the intrinsic value of any other stock, do a search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.