How far off is Enphase Energy, Inc. (NASDAQ:ENPH) from its intrinsic value? Using the most recent financial data, we’ll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today’s value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. There’s really not all that much to it, even though it might appear quite complex.

Remember though, that there are many ways to estimate a company’s value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for Enphase Energy

The method

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. To begin with, we have to get estimates of 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:

10-year free cash flow (FCF) forecast

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

Levered FCF ($, Millions)

US$346.9m

US$497.9m

US$987.0m

US$1.30b

US$1.54b

US$1.74b

US$1.91b

US$2.06b

US$2.18b

US$2.28b

Growth Rate Estimate Source

Analyst x11

Analyst x5

Analyst x1

Analyst x1

Est @ 18.19%

Est @ 13.33%

Est @ 9.93%

Est @ 7.55%

Est @ 5.88%

Est @ 4.71%

Present Value ($, Millions) Discounted @ 7.4%

US$323

US$432

US$797

US$977

US$1.1k

US$1.1k

US$1.2k

US$1.2k

US$1.1k

US$1.1k

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$9.3b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.0%) 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 7.4%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$2.3b× (1 + 2.0%) ÷ (7.4%– 2.0%) = US$43b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$43b÷ ( 1 + 7.4%)10= US$21b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$30b. 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$165, the company appears a touch undervalued at a 26% 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.

dcf

The assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Enphase Energy 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 7.4%, which is based on a levered beta of 1.145. 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. The DCF model is not a perfect stock valuation tool. Preferably you’d apply different cases and assumptions and see how they would impact the company’s valuation. For example, changes in the company’s cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For Enphase Energy, we’ve compiled three additional items you should further research:

  1. Risks: As an example, we’ve found 6 warning signs for Enphase Energy that you need to consider before investing here.

  2. Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for ENPH’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.

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