The intrinsic value of Credo Technology Group Holding Ltd (NASDAQ:CRDO) is potentially 84% higher than its stock price

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How far is Credo Technology Group Holding Ltd (NASDAQ:CRDO) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by taking 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. There really isn’t much to do, although it may seem quite complex.

We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws. If you want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St analysis template.

Check out our latest analysis for Credo Technology Group Holding

The model

We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. In the first step, we need to estimate the company’s cash flow over the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.

Generally, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:

Estimated free cash flow (FCF) over 10 years

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leveraged FCF ($, millions) -$36.3 million $1.15 million $53.9 million $93.6 million $120.6 million $157.3 million $185.0 million $208.8 million $228.9 million $245.6 million
Growth rate estimate Source Analyst x1 Analyst x2 Analyst x2 Analyst x1 Analyst x1 Analyst x1 East @ 17.6% Is at 12.89% Is at 9.6% Is at 7.3%
Present value (millions of dollars) discounted at 6.8% -US$34.0 $1.0 $44.2 $72.0 $86.9 $106 $117 $124 $127 $127

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $771 million

We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.9%. We discount the terminal cash flows to their present value at a cost of equity of 6.8%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = $246 million × (1 + 1.9%) ÷ (6.8%–1.9%) = $5.2 billion

Present value of terminal value (PVTV)= TV / (1 + r)ten= $5.2 billion ÷ (1 + 6.8%)ten= $2.7 billion

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $3.4 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of US$12.9, the company appears to be pretty good value at a 46% discount to the current share price. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.

NasdaqGS: CRDO Discounted Cash Flow June 3, 2022

The hypotheses

We emphasize 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 entries, I recommend you redo the calculations yourself and play around with them. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Credo Technology Group Holding 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 takes debt into account. In this calculation, we used 6.8%, which is based on a leveraged beta of 1.146. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Next steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it’s just one of many factors you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. Why is the stock price below intrinsic value? For Credo Technology Group Holding, we have compiled three relevant factors that you should explore:

  1. Risks: We believe that you should evaluate the 1 warning sign for Credo Technology Group Holding we reported before investing in the company.
  2. Future earnings: How does CRDO’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
  3. Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of ​​what you might be missing!

PS. Simply Wall St updates its DCF calculation for every US stock daily, so if you want to find the intrinsic value of any other stock, do a search here.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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