Today we will run through one way of estimating the intrinsic value of Absolute Software Corporation (TSE:ABST) by taking the expected future cash flows and discounting them to today’s value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it’s quite simple!
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
See our latest analysis for Absolute Software
Step By Step Through The Calculation
We are going to use a twostage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. 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 reduced free cash flow will slow their rate of depreciation, 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 need to discount the sum of these future cash flows to arrive at a present value estimate:
10year free cash flow (FCF) forecast
2023 
2024 
2025 
2026 
2027 
2028 
2029 
2030 
2031 
2032 

Leveraged FCF ($, Millions) 
US$31.0m 
US$40.2m 
US$42.0m 
US$43.5m 
US$44.9m 
US$46.1m 
US$47.2m 
US$48.3m 
US$49.3m 
US$50.2m 
Growth Rate Estimate Source 
Analysts x2 
Analysts x2 
Est @ 4.48% 
Est @ 3.66% 
Est @ 3.09% 
Est @ 2.69% 
Est @ 2.41% 
Est @ 2.22% 
Est @ 2.08% 
Est @ 1.98% 
Present Value ($, Millions) Discounted @ 9.2% 
US$28.4 
US$33.7 
US$32.2 
US$30.6 
US$28.9 
US$27.1 
US$25.5 
US$23.8 
US$22.3 
US$20.8 
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10year Cash Flow (PVCF) = US$273m
After calculating the present value of future cash flows in the initial 10year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 5year average of the 10year government bond yield (1.8%) to estimate future growth. In the same way as with the 10year ‘growth’ period, we discount future cash flows to today’s value, using a cost of equity of 9.2%.
Terminal Value (TV)= FCF_{2032} × (1 + g) ÷ (r – g) = US$50m× (1 + 1.8%) ÷ (9.2%– 1.8%) = US$685m
Present Value of Terminal Value (PVTV)= TV / (1 + r)^{10}= US$685m÷ ( 1 + 9.2%)^{10}= US$283m
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$557m. The last step is to then divide the equity value by the number of outstanding shares. Relative to the current share price of CA$12.4, the company appears about fair value at a 13% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
The Assumptions
We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don’t agree with these results, have a go at the calculations yourself and play with the 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 Absolute Software 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 9.2%, which is based on a leveraged beta of 1.257. 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.
SWOT Analysis for Absolute Software
strength
Weaknesses
Opportunity
Threats
Looking Ahead:
Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It’s not possible to obtain a foolproof valuation with a DCF model. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Absolute Software, we’ve put together three further factors you should further examine:

risks: As an example, we’ve found 4 warning signs for Absolute Software (1 is concerning!) that you need to consider before investing here.

Future Earnings: How does ABST’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.

Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the TSX every day. If you want to find the calculation for other stocks, just search here.
Have feedback on this article? Concerned about the content? get in touch with us directly. Alternatively, email editorialteam (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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 longterm focused analysis driven by fundamental data. Note that our analysis may not factor in the latest pricesensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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