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A Look At The Fair Value Of Synopsys, Inc. (NASDAQ:SNPS)

Key Insights

  • Synopsys' estimated fair value is US$538 based on 2 Stage Free Cash Flow to Equity

  • With US$489 share price, Synopsys appears to be trading close to its estimated fair value

  • Our fair value estimate is 15% lower than Synopsys' analyst price target of US$634

In this article we are going to estimate the intrinsic value of Synopsys, Inc. (NASDAQ:SNPS) by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

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.

Check out our latest analysis for Synopsys

What's The Estimated Valuation?

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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) forecast

2025

2026

2027

2028

2029

2030

2031

2032

2033

2034

Levered FCF ($, Millions)

US$1.70b

US$2.07b

US$2.39b

US$2.95b

US$3.34b

US$3.67b

US$3.96b

US$4.20b

US$4.41b

US$4.60b

Growth Rate Estimate Source

Analyst x5

Analyst x3

Analyst x2

Analyst x1

Est @ 13.23%

Est @ 10.01%

Est @ 7.76%

Est @ 6.18%

Est @ 5.08%

Est @ 4.30%

Present Value ($, Millions) Discounted @ 6.6%

US$1.6k

US$1.8k

US$2.0k

US$2.3k

US$2.4k

US$2.5k

US$2.5k

US$2.5k

US$2.5k

US$2.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$23b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.5%. We discount the terminal cash flows to today's value at a cost of equity of 6.6%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$4.6b× (1 + 2.5%) ÷ (6.6%– 2.5%) = US$114b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$114b÷ ( 1 + 6.6%)10= US$60b

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. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$489, the company appears about fair value at a 9.2% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
dcf

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Synopsys 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 6.6%, which is based on a levered beta of 1.002. 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 Synopsys

Strength

  • Earnings growth over the past year exceeded the industry.

  • Debt is not viewed as a risk.

Weakness

  • No major weaknesses identified for SNPS.

Opportunity

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

  • Current share price is below our estimate of fair value.

Threat

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

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. 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 Synopsys, we've put together three further elements you should further examine:

  1. Financial Health: Does SNPS have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.

  2. Future Earnings: How does SNPS'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. 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.

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.