Australia markets open in 7 hours 34 minutes
  • ALL ORDS

    7,759.30
    +5.00 (+0.06%)
     
  • AUD/USD

    0.7508
    +0.0013 (+0.17%)
     
  • ASX 200

    7,443.40
    +2.40 (+0.03%)
     
  • OIL

    84.32
    +0.56 (+0.67%)
     
  • GOLD

    1,789.90
    -16.90 (-0.94%)
     
  • BTC-AUD

    82,733.36
    -2,157.99 (-2.54%)
     
  • CMC Crypto 200

    1,492.27
    -12.88 (-0.86%)
     

Alarm.com Holdings, Inc. (NASDAQ:ALRM) Shares Could Be 35% Above Their Intrinsic Value Estimate

  • Oops!
    Something went wrong.
    Please try again later.
·6-min read
In this article:
  • Oops!
    Something went wrong.
    Please try again later.

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Alarm.com Holdings, Inc. (NASDAQ:ALRM) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for Alarm.com Holdings

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 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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$113.1m

US$126.0m

US$135.5m

US$143.5m

US$150.2m

US$156.1m

US$161.3m

US$166.0m

US$170.4m

US$174.6m

Growth Rate Estimate Source

Analyst x2

Analyst x1

Est @ 7.55%

Est @ 5.88%

Est @ 4.71%

Est @ 3.9%

Est @ 3.33%

Est @ 2.92%

Est @ 2.64%

Est @ 2.45%

Present Value ($, Millions) Discounted @ 6.7%

US$106

US$111

US$111

US$111

US$108

US$106

US$102

US$98.6

US$94.8

US$91.0

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.0b

After calculating the present value of future cash flows in the initial 10-year 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 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 6.7%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$175m× (1 + 2.0%) ÷ (6.7%– 2.0%) = US$3.8b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$3.8b÷ ( 1 + 6.7%)10= US$2.0b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$3.0b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$80.9, the company appears reasonably expensive at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
dcf

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. 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 Alarm.com Holdings 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 6.7%, which is based on a levered beta of 1.005. 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 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. Why is the intrinsic value lower than the current share price? For Alarm.com Holdings, there are three essential factors you should assess:

  1. Risks: Case in point, we've spotted 2 warning signs for Alarm.com Holdings you should be aware of, and 1 of them is a bit unpleasant.

  2. Future Earnings: How does ALRM'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.

  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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks just search here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

Our goal is to create a safe and engaging place for users to connect over interests and passions. In order to improve our community experience, we are temporarily suspending article commenting