How far is elf Beauty, Inc. (NYSE: ELF) from its intrinsic value? Using the most recent financial data, we’ll examine whether the stock’s price is fair by taking expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too hard to follow, as you will see in our example!
Remember, however, that there are many ways to estimate the value of a business, and a DCF is just one method. Anyone interested in knowing a little more about intrinsic value should read the Simply Wall St analysis model.
Step by step in the calculation
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. To begin with, we need to get cash flow estimates for the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated 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 down more in the early years than in subsequent years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and therefore the sum of those future cash flows is then discounted to today’s value. :
10-year free cash flow (FCF) forecast
| 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
| Leverage FCF ($, Millions) | US $ 36.5 million | US $ 45.5 million | US $ 54.2 million | US $ 56.7 million | 58.5 million US dollars | US $ 59.9 million | US $ 61.4 million | US $ 62.7 million | US $ 64.1 million | US $ 65.5 million |
| Source of estimated growth rate | Analyst x2 | Analyst x2 | Analyst x2 | Analyst x1 | Analyst x1 | Is 2.53% | East @ 2.37% | Is @ 2.25% | Est @ 2.17% | Is @ 2.12% |
| Present value (in millions of dollars) discounted at 6.8% | US $ 34.2 | US $ 39.9 | $ 44.6 | US $ 43.6 | US $ 42.1 | US $ 40.4 | US $ 38.8 | US $ 37.1 | US $ 35.5 | US $ 34.0 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 390 million US dollars
The second stage is also known as terminal value, this is the cash flow of the business after the first stage. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to their present value at a cost of equity of 6.8%.
Terminal value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US $ 65 million × (1 + 2.0%) ÷ (6.8% – 2.0%) = US $ 1.4 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= US $ 1.4 billion ÷ (1 + 6.8%)ten= US $ 724 million
Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is US $ 1.1 billion. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of $ 28.5, the company looks potentially overvalued at the time of writing. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
NYSE: ELF Discounted Cash Flow June 14, 2021
Important assumptions
Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play 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 view elf Beauty 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 6.8%, which is based on a leveraged beta of 1.014. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
To move on :
While a business valuation is important, ideally, it won’t be the only analysis you look at for a business. It is not possible to achieve a rock-solid valuation with a DCF model. 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 dramatically change the overall result. Why is intrinsic value lower than the current share price? For Elf Beauty, we’ve put together three more things you should take a closer look at:
- Risks: Concrete example, we have spotted 5 warning signs for the beauty of elves you must be aware of this, and one of them must not be ignored.
- Future benefits: How does ELF’s growth rate compare to that of its peers and the broader market? Deepen the number of analyst consensus for the coming years by interacting with our free chart of analysts’ growth expectations.
- Other high quality alternatives: Do you like a good all-rounder? To explore our interactive list of high quality actions to get an idea of what else you might be missing!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for every NYSE share. If you want to find the calculation for other actions just search here.
This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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