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The projected fair value for Netflix is US$778 based on 2 Stage Free Cash Flow to Equity
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Current share price of US$795 suggests Netflix is potentially trading close to its fair value
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Analyst price target for NFLX is US$761 which is 2.3% below our fair value estimate
How far off is Netflix, Inc. (NASDAQ:NFLX) from its intrinsic value? Using the most recent financial data, we’ll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today’s value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they’re fairly easy to follow.
Remember though, that there are many ways to estimate a company’s value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
See our latest analysis for Netflix
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren’t available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:
|
2025 |
2026 |
2027 |
2028 |
2029 |
2030 |
2031 |
2032 |
2033 |
2034 |
|
|
Levered FCF ($, Millions) |
US$8.99b |
US$10.8b |
US$13.1b |
US$15.0b |
US$16.4b |
US$17.6b |
US$18.7b |
US$19.6b |
US$20.4b |
US$21.2b |
|
Growth Rate Estimate Source |
Analyst x21 |
Analyst x19 |
Analyst x8 |
Analyst x6 |
Est @ 9.50% |
Est @ 7.44% |
Est @ 5.99% |
Est @ 4.98% |
Est @ 4.27% |
Est @ 3.78% |
|
Present Value ($, Millions) Discounted @ 7.3% |
US$8.4k |
US$9.3k |
US$10.6k |
US$11.3k |
US$11.5k |
US$11.5k |
US$11.4k |
US$11.1k |
US$10.8k |
US$10.4k |
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$106b
The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.6%. We discount the terminal cash flows to today’s value at a cost of equity of 7.3%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$21b× (1 + 2.6%) ÷ (7.3%– 2.6%) = US$460b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$460b÷ ( 1 + 7.3%)10= US$227b
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$333b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$795, the company appears around fair value at the time of writing. 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.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. You don’t have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Netflix 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 7.3%, which is based on a levered beta of 1.147. 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.
Strength
Weakness
Opportunity
Threat
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Netflix, there are three relevant aspects you should further examine:
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Financial Health: Does NFLX have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
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Future Earnings: How does NFLX’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.
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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. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (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 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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