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Estimating The Intrinsic Value Of Align Technology, Inc. (NASDAQ:ALGN)

Key Insights

  • The projected fair value for Align Technology is US$297 based on 2 Stage Free Cash Flow to Equity

  • With US$315 share price, Align Technology appears to be trading close to its estimated fair value

  • Analyst price target for ALGN is US$313, which is 5.4% above our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Align Technology, Inc. (NASDAQ:ALGN) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.

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.

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Check out our latest analysis for Align Technology

The Method

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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF ($, Millions)

US$745.3m

US$811.4m

US$834.7m

US$946.5m

US$1.00b

US$1.05b

US$1.09b

US$1.13b

US$1.17b

US$1.20b

Growth Rate Estimate Source

Analyst x5

Analyst x6

Analyst x4

Analyst x2

Est @ 5.95%

Est @ 4.85%

Est @ 4.08%

Est @ 3.54%

Est @ 3.17%

Est @ 2.90%

Present Value ($, Millions) Discounted @ 6.5%

US$700

US$715

US$690

US$735

US$731

US$719

US$703

US$683

US$661

US$639

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$7.0b

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 6.5%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$1.2b× (1 + 2.3%) ÷ (6.5%– 2.3%) = US$29b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$29b÷ ( 1 + 6.5%)10= US$15b

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$22b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$315, the company appears around fair value at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
dcf

Important 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 Align Technology 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 6.5%, which is based on a levered beta of 0.923. 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 Align Technology

Strength

  • Earnings growth over the past year exceeded the industry.

  • Currently debt free.

Weakness

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

Opportunity

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

Threat

  • Annual revenue is forecast to grow slower than the American market.

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Align Technology, we've compiled three further elements you should further research:

  1. Risks: For instance, we've identified 1 warning sign for Align Technology that you should be aware of.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for ALGN's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

  3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS 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.