The Trade Desk, Inc.'s (NASDAQ:TTD) Intrinsic Value Is Potentially 21% Below Its Share Price

Key Insights

• The projected fair value for Trade Desk is US$61.25 based on 2 Stage Free Cash Flow to Equity

• Trade Desk is estimated to be 26% overvalued based on current share price of US$77.30

• The US$94.34 analyst price target for TTD is 54% more than our estimate of fair value

In this article we are going to estimate the intrinsic value of The Trade Desk, Inc. (NASDAQ:TTD) by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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.

Check out our latest analysis for Trade Desk

Is Trade Desk Fairly Valued?

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. 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, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$711.2m	US$839.8m	US$980.7m	US$1.09b	US$1.17b	US$1.25b	US$1.31b	US$1.37b	US$1.42b	US$1.47b
Growth Rate Estimate Source	Analyst x5	Analyst x5	Analyst x3	Est @ 10.66%	Est @ 8.15%	Est @ 6.39%	Est @ 5.16%	Est @ 4.30%	Est @ 3.70%	Est @ 3.27%
Present Value ($, Millions) Discounted @ 6.1%	US$670	US$746	US$821	US$856	US$873	US$875	US$867	US$852	US$833	US$811

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$8.2b

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 (2.3%) 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 6.1%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$1.5b× (1 + 2.3%) ÷ (6.1%– 2.3%) = US$39b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$39b÷ ( 1 + 6.1%)¹⁰= US$22b

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$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$77.3, the company appears slightly overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

Important Assumptions

Now 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 result, have a go at the calculation 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 Trade Desk 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 6.1%, which is based on a levered beta of 0.830. 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 Trade Desk

Strength

• Earnings growth over the past year exceeded the industry.

• Currently debt free.

Weakness

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

Opportunity

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

Threat

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

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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. What is the reason for the share price exceeding the intrinsic value? For Trade Desk, there are three essential elements you should explore:

1. Financial Health: Does TTD 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.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for TTD'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 NASDAQGM every day. If you want to find the calculation for other stocks just search here.

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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.