Key insights
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American Software’s estimated fair value is US$12.17, based on two-stage free cash flow to equity
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The current share price of US$11.45 suggests that American Software may be trading close to its fair value
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The analyst price target of US$16.33 for AMSW.A is 34% higher than our fair value estimate
Today we will discuss one way to assess the intrinsic value of American Software, Inc. (NASDAQ:AMSW.A) by taking the expected future cash flows and discounting them to their present value. On this occasion we will use the Discounted Cash Flow (DCF) model. Believe it or not, it’s not that hard to follow, as you’ll see in our example!
We caution that there are many ways to value a company and that each technique, like the DCF, has advantages and disadvantages in certain scenarios. If you still have burning questions about these types of valuations, take a look at the Simply Wall St analysis model.
Check out our latest analysis for American Software
The method
We use what is called a two-phase model, which simply means that we have two different growth periods for the company’s cash flows. Generally, the first stage is higher growth and the second stage is lower growth. In the first stage we need to estimate the cash flows to the company over the next ten years. Where possible we use analyst estimates, but if these are not available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate, over this period. We do this to reflect that growth typically slows more in the early years than in later years.
We generally assume that a dollar today is more valuable than a dollar in the future, and therefore the sum of these future cash flows is then discounted to today’s value:
Free cash flow (FCF) estimate over 10 years
2024 |
2025 |
2026 |
2027 |
2028 |
2029 |
2030 |
2031 |
2032 |
2033 |
|
Levered FCF ($, millions) |
$17.4 million |
$17.9 million |
$19.1 million |
$19.7 million |
$20.2 million |
$20.8 million |
$21.3 million |
$21.8 million |
$22.4 million |
$22.9 million |
Source of estimated growth rate |
Analyst x1 |
Analyst x1 |
Analyst x1 |
Is @ 3.05% |
Is @ 2.82% |
Is @ 2.66% |
Is @ 2.55% |
Is @ 2.47% |
Is @ 2.42% |
Is @ 2.38% |
Present value ($, millions) discounted @ 6.9% |
$16.3 |
$15.7 |
$15.6 |
$15.1 |
$14.5 |
US$13.9 |
$13.4 |
$12.8 |
$12.3 |
$11.8 |
(“Est” = FCF growth rate estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = $141 million
After calculating the present value of future cash flows in the first ten-year period, we need to calculate the terminal value, which takes into account all future cash flows after the first stage. The Gordon Growth formula is used to calculate terminal value at a future annual growth rate equal to the five-year average of the ten-year government bond yield of 2.3%. We discount the terminal cash flows to present value at a cost of equity of 6.9%.
Final value (TV)= FCF2033 × (1 + g) ÷ (r – g) = $23 million × (1 + 2.3%) ÷ (6.9% – 2.3%) = $511 million
Current Value of Final Value (PVTV)= TV / (1 + r)10= US$511 million ( 1 + 6.9%)10= $263 million
The total value is the sum of the cash flows for the next ten years plus the discounted terminal value, resulting in the Total Equity Value, which in this case is $404 million. The final step is to then divide the share value by the number of shares outstanding. Compared to the current share price of $11.5, the company looks about at its fair value at a 5.9% discount to the current share price. However, keep in mind that this is only an estimated valuation, and like any complex formula: garbage in, garbage out.
The assumptions
We would like to point out that the most important input to a discounted cash flow is the discount rate and of course the actual cash flows. You do not have to agree with this entry. I recommend that you redo the calculations yourself and play around with them. The DCF also does not take into account the potential cyclicality of an industry, or a company’s future capital requirements, and thus does not provide a complete picture of a company’s potential performance. Since we consider American 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 takes debt into account. In this calculation we used 6.9%, based on a levered beta of 0.997. Beta is a measure of a stock’s volatility compared to the market as a whole. We take 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 company.
SWOT analysis for US software
power
Weakness
Possibility
Threat
Looking forward:
While a company’s valuation is important, it is only one of many factors you should evaluate for a company. The DCF model is not a perfect tool for valuing shares. Ideally, you would apply different cases and assumptions and see how they would affect the company’s valuation. For example, changes in the company’s cost of equity or risk-free interest rate can have a significant impact on valuation. For American Software, we’ve put together three relevant items for you to review:
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Risks: Please note that American Software is listed 3 warning signs in our investment analysis and one of them is a bit worrying…
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Future earnings: How does AMSW.A’s growth rate compare to its competitors and the broader market? Dive deeper into the analyst consensus rating for the coming years by using our free analyst growth forecast chart.
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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 you could be missing!
P.S. Simply Wall St updates the DCF calculation for every US stock every day, so if you want to find the intrinsic value of another stock, just search here.
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This article from Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts using only an unbiased methodology and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. We aim to provide you with targeted, long-term analysis based on fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or quality material. Simply Wall St has no positions in the stocks mentioned.