An Intrinsic Calculation For Salesforce, Inc. (NYSE:CRM) Suggests It's 32% Undervalued

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Salesforce fair value estimate is US$311

• Salesforce's US$210 share price signals that it might be 32% undervalued

• Our fair value estimate is 37% higher than Salesforce's analyst price target of US$228

In this article we are going to estimate the intrinsic value of Salesforce, Inc. (NYSE:CRM) by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Salesforce

Step By Step Through The Calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. 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

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	US$5.99b	US$7.42b	US$9.85b	US$11.8b	US$14.5b	US$18.4b	US$21.2b	US$23.6b	US$25.6b	US$27.3b
Growth Rate Estimate Source	Analyst x26	Analyst x26	Analyst x25	Analyst x11	Analyst x3	Analyst x3	Est @ 15.21%	Est @ 11.28%	Est @ 8.53%	Est @ 6.60%
Present Value ($, Millions) Discounted @ 8.3%	US$5.5k	US$6.3k	US$7.8k	US$8.6k	US$9.7k	US$11.4k	US$12.2k	US$12.5k	US$12.6k	US$12.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$99b

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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 8.3%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$27b× (1 + 2.1%) ÷ (8.3%– 2.1%) = US$454b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$454b÷ ( 1 + 8.3%)¹⁰= US$206b

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$305b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$210, the company appears quite good value at a 32% 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.

dcf

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Salesforce 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 8.3%, which is based on a levered beta of 1.034. 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 Salesforce

Strength

• Debt is not viewed as a risk.

Weakness

• Earnings declined over the past year.

Opportunity

• Annual earnings are forecast to grow faster than the American market.

• Good value based on P/S ratio and estimated fair value.

Threat

• Revenue is forecast to grow slower than 20% per year.

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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Salesforce, we've compiled three further aspects you should further research:

1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Salesforce , and understanding these should be part of your investment process.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CRM'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE 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 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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