A Look At The Fair Value Of Lam Research Corporation (NASDAQ:LRCX)

Key Insights

• Using the 2 Stage Free Cash Flow to Equity, Lam Research fair value estimate is US$618

• With US$497 share price, Lam Research appears to be trading close to its estimated fair value

• Our fair value estimate is 20% higher than Lam Research's analyst price target of US$517

In this article we are going to estimate the intrinsic value of Lam Research Corporation (NASDAQ:LRCX) by taking the forecast future cash flows of the company and discounting them back to today's 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.

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.

See our latest analysis for Lam Research

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. To start off with, we need to estimate 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) estimate

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	US$5.64b	US$3.22b	US$4.14b	US$4.62b	US$5.95b	US$6.79b	US$7.50b	US$8.10b	US$8.60b	US$9.03b
Growth Rate Estimate Source	Analyst x9	Analyst x8	Analyst x7	Analyst x2	Analyst x1	Est @ 14.14%	Est @ 10.52%	Est @ 7.98%	Est @ 6.21%	Est @ 4.97%
Present Value ($, Millions) Discounted @ 9.8%	US$5.1k	US$2.7k	US$3.1k	US$3.2k	US$3.7k	US$3.9k	US$3.9k	US$3.8k	US$3.7k	US$3.5k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$37b

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 (2.1%) 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 9.8%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$9.0b× (1 + 2.1%) ÷ (9.8%– 2.1%) = US$119b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$119b÷ ( 1 + 9.8%)¹⁰= US$47b

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$83b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$497, the company appears about fair value at a 20% 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.

dcf

Important Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 Lam Research 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 9.8%, which is based on a levered beta of 1.304. 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 Lam Research

Strength

• Debt is not viewed as a risk.

• Dividends are covered by earnings and cash flows.

Weakness

• Earnings growth over the past year underperformed the Semiconductor industry.

• Dividend is low compared to the top 25% of dividend payers in the Semiconductor market.

Opportunity

• Annual earnings are forecast to grow for the next 3 years.

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

Threat

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

Looking Ahead:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. 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 Lam Research, there are three further aspects you should look at:

1. Risks: Take risks, for example - Lam Research has 1 warning sign we think you should be aware of.

2. Future Earnings: How does LRCX'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.

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.

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