Yahoo Finance Is Aehr Test Systems (NASDAQ:AEHR) Expensive For A Reason? A Look At Its Intrinsic Value
Key Insights
Aehr Test Systems' estimated fair value is US$8.95 based on 2 Stage Free Cash Flow to Equity
Aehr Test Systems is estimated to be 28% overvalued based on current share price of US$11.47
When compared to theindustry average discount of -60%, Aehr Test Systems' competitors seem to be trading at a greater premium to fair value
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Aehr Test Systems (NASDAQ:AEHR) 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. 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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Check out our latest analysis for Aehr Test Systems
Step By Step Through The Calculation
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. In the first stage we need to estimate the cash flows to the business over the next ten years. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$7.70m | US$10.1m | US$12.4m | US$14.4m | US$16.2m | US$17.7m | US$18.9m | US$20.0m | US$20.9m | US$21.8m |
Growth Rate Estimate Source | Est @ 43.61% | Est @ 31.21% | Est @ 22.54% | Est @ 16.46% | Est @ 12.21% | Est @ 9.23% | Est @ 7.15% | Est @ 5.69% | Est @ 4.67% | Est @ 3.96% |
Present Value ($, Millions) Discounted @ 8.5% | US$7.1 | US$8.6 | US$9.7 | US$10.4 | US$10.8 | US$10.9 | US$10.7 | US$10.5 | US$10.1 | US$9.7 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$98m
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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 8.5%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$22m× (1 + 2.3%) ÷ (8.5%– 2.3%) = US$361m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$361m÷ ( 1 + 8.5%)10= US$160m
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$259m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$11.5, 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.
The Assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Aehr Test Systems 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 8.5%, which is based on a levered beta of 1.341. 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.
Looking Ahead:
Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value lower than the current share price? For Aehr Test Systems, there are three further aspects you should further research:
Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with Aehr Test Systems (at least 2 which are significant) , and understanding these should be part of your investment process.
Future Earnings: How does AEHR'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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock 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.
