- Using the 2 Stage Free Cash Flow to Equity, Streamline Health Solutions fair value estimate is US$1.63
- Streamline Health Solutions’ US$0.92 share price signals that it might be 43% undervalued
- Streamline Health Solutions’ peers seem to be trading at a lower discount to fair value based onthe industry average of 22%
Does the October share price for Streamline Health Solutions, Inc. (NASDAQ:STRM) reflect what it’s really worth? Today, we will estimate the stock’s intrinsic value by taking the forecast future cash flows of the company and discounting them back to today’s value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don’t get put off by the jargon, the math behind it is actually quite straightforward.
We generally believe that a company’s value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
View our latest analysis for Streamline Health Solutions
We’re using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren’t available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today’s value:
10-year free cash flow (FCF) estimate
|Levered FCF ($, Millions)||-US$6.77m||-US$5.11m||-US$1.68m||US$1.83m||US$3.26m||US$4.46m||US$5.63m||US$6.71m||US$7.65m||US$8.45m|
|Growth Rate Estimate Source||Analyst x1||Analyst x1||Analyst x1||Analyst x1||Analyst x1||Est @ 36.74%||Est @ 26.36%||Est @ 19.10%||Est @ 14.01%||Est @ 10.46%|
|Present Value ($, Millions) Discounted @ 7.3%||-US$6.3||-US$4.4||-US$1.4||US$1.4||US$2.3||US$2.9||US$3.4||US$3.8||US$4.0||US$4.2|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$9.9m
The second stage is also known as Terminal Value, this is the business’s cash flow after 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 (2.2%) 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 7.3%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$8.5m× (1 + 2.2%) ÷ (7.3%– 2.2%) = US$166m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$166m÷ ( 1 + 7.3%)10= US$82m
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$92m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$0.9, the company appears quite undervalued at a 43% 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.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Streamline Health Solutions 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 1.039. 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 Streamline Health Solutions
- Debt is well covered by earnings.
- Shareholders have been diluted in the past year.
- Forecast to reduce losses next year.
- Trading below our estimate of fair value by more than 20%.
- Debt is not well covered by operating cash flow.
- Has less than 3 years of cash runway based on current free cash flow.
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to “what assumptions need to be true for this stock to be under/overvalued?” 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 sitting below the intrinsic value? For Streamline Health Solutions, we’ve compiled three relevant items you should assess:
- Risks: Every company has them, and we’ve spotted 5 warning signs for Streamline Health Solutions (of which 1 is significant!) you should know about.
- Future Earnings: How does STRM’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.
- 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 NASDAQCM every day. If you want to find the calculation for other stocks just search here.
Valuation is complex, but we’re helping make it simple.
Find out whether Streamline Health Solutions is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
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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.