Today we’re doing a simple run of a valuation methodology that will estimate the attractiveness of Tandem Diabetes Care, Inc. (NASDAQ: TNDM) as an investment opportunity by projecting future cash flows and then discounting it to today’s value. This is done according to the DCF model (Discounted Cash Flow). Models like this may seem beyond the understanding of a layperson, but are fairly easy to follow.
Remember, however, that there are many ways to appreciate a company’s value, and a DCF is just one method. If you want to find out more about the intrinsic value, you should read the Simply Wall St analysis model.
Check out our latest analysis for Tandem Diabetes Care
We use the two-tier growth model, which simply means that we consider two stages in the company’s growth. In the initial phase, the company can have a higher growth rate, and for the second phase, a stable growth rate is usually assumed. In the first phase, we need to estimate the cash flows for the business over the next ten years. We use analyst estimates whenever possible. However, if these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume that companies with shrinking free cash flow will slow their rate of contraction and that companies with increasing free cash flow will slow their growth rate over this period. We do this to reflect that growth tends to slow down more in the early years than in later years.
A DCF is all about the idea that a dollar in the future is worth less than a dollar today. Therefore, the sum of these future cash flows is discounted to today’s value:
10-year free cash flow forecast (FCF)
|Leverage FCF ($, million)||$ 68.6 million||$ 104.0 million||$ 215.5 million||$ 302.5 million||$ 389.9 million||$ 471.1 million||$ 542.7 million||$ 603.7 million||$ 654.9 million||$ 697.8 million|
|Source for growth rate estimation||Analyst x3||Analyst x3||Analyst x1||Est @ 40.38%||Est @ 28.88%||Est @ 20.83%||Est @ 15.19%||Est @ 11.25%||Est @ 8.48%||Est @ 6.55%|
|Present Value ($, Million) Discounted 6.6%||$ 64.4||$ 91.6||US $ 178||US $ 235||$ 284||US $ 322||US $ 348||US $ 363||US $ 370||US $ 370|
(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = US $ 2.6b
The second level is also known as Terminal Value. This is the company’s cash flow after the first stage. A very conservative growth rate is used that cannot exceed that of any country’s GDP growth for a number of reasons. In this case, we used the 5-year average 10-year government bond yield (2.0%) to estimate future growth. Similar to the 10-year growth phase, we discount future cash flows to today’s value using a cost of equity of 6.6%.
Terminal value (TV)= FCF2030 × (1 + g) ≤ (r – g) = US $ 698 million × (1 + 2.0%) ≤ (6.6% – 2.0%) = US $ 16b
Present value of the terminal value (PVTV)= TV / (1 + r) 10 = $ 16 billion ÷ (1 + 6.6%) 10 = $ 8.4 billion
The total or equity value is then the sum of the present value of the future cash flows, which in this case is $ 11 billion. In the final step, we divide the equity value by the number of shares issued. Compared to its current share price of $ 101, the company appears to be fairly undervalued, at a 43% discount to the current share price. Ratings, however, are inaccurate instruments, more like a telescope – move a few degrees and land in a different galaxy. Keep that in mind.
NasdaqGM: TNDM Discounted Cash Flow February 9, 2021
The most important inputs for a discounted cash flow are now the discount rate and of course the actual cash flows. Part of the investment is making your own assessment of a company’s future performance. So try the calculation yourself and check your own assumptions. The DCF also does not take into account the possible cyclical nature of an industry or the future capital requirements of a company, so it does not give a complete picture of a company’s potential performance. Given that we view Tandem Diabetes Care as a potential shareholder, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) responsible for debt. In this calculation we used 6.6% based on a leverage beta of 0.864. Beta is a measure of the volatility of a stock compared to the overall market. We get our beta from the industry-standard average beta of globally comparable companies with a set limit between 0.8 and 2.0, which is a reasonable range for a stable business.
The DCF calculation is important, but it is only one of many factors that you have to evaluate for a company. The DCF model is not a perfect tool for stock valuation. Instead, the best use for a DCF model is to test certain assumptions and theories to determine whether they would result in the company being undervalued or overvalued. For example, adjusting the terminal value growth rate slightly can change the overall result dramatically. Why is the intrinsic value higher than the current share price? For Tandem Diabetes Care, there are three basic points that you should investigate further:
- Risks: As an example we found 2 warning signs for tandem diabetes care you need to consider this before investing here.
- Future earnings: What is TNDM’s growth rate compared to its competitors and the broader market? Learn more about analyst consensus number for the years to come by interacting with our free analyst growth expectation chart.
- Other solid companies: Low debt, high returns on equity, and good past performance are fundamental to a strong business. Check out our interactive list of stocks with solid business fundamentals to see if there are any other companies you might not have considered!
PS. Simply Wall St updates its DCF calculation for every American share daily. So if you want to find out the intrinsic value of any other stock, just search here.
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This article from Simply Wall St is of a general nature. It is not a recommendation to buy or sell stocks and does not take into account your goals or your financial situation. We want to provide you with a long-term, focused analysis based on fundamental data. Note that our analysis may not take into account the latest price sensitive company announcements or quality materials. Simply Wall St has no position in the stocks mentioned.
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