Estimate of fair value of Sapiens International Corporation NV (NASDAQ:SPNS)

Key findings

• The projected fair value for Sapiens International is $40.09 based on 2-step Free Cash Flow to Equity
• Sapiens International’s share price of $37.42 suggests that the share price is at a similar level to the estimated fair value
• The analyst price target of $34.40 for SPNS is 14% below our fair value estimate

Does Sapiens International Corporation NV (NASDAQ:SPNS)’s July share price reflect its true value? Today we’ll estimate the stock’s intrinsic value by taking the expected future cash flows and discounting them to their present value using the discounted cash flow (DCF) model. Before you think you can’t understand it, just keep reading! It’s actually a lot less complex than you think.

Companies can be valued in many ways, so we would like to point out that a DCF is not perfect for every situation. If you still have pressing questions about this type of valuation, take a look at Simply Wall St’s analysis model.

Check out our latest analysis for Sapiens International

Step by step through the calculation

We use what is called a 2-stage model, which simply means that we have two different growth periods for the company’s cash flows. Generally speaking, the first stage is one of higher growth, and the second stage is one of lower growth. First, we need to get estimates for 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 that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate, over this period. We do this to take into account that growth tends to slow more in the early years than in later years.

A DCF is based on the idea that a dollar in the future is worth less than a dollar today. Therefore, the sum of these future cash flows is discounted to today’s value:

Estimation of free cash flow (FCF) over 10 years

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 883 million US dollars

We now need to calculate the terminal value that takes into account all future cash flows after this ten-year period. For various reasons, a very conservative growth rate is used that cannot exceed a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (2.4%) 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 8.0%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = 162 million US dollars × (1 + 2.4%) ÷ (8.0% – 2.4%) = 2.9 billion US dollars

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 2.9 billion US dollars ÷ (1 + 8.0%)¹⁰= 1.4 billion US dollars

The total value or equity value is then the sum of the present value of future cash flows, which in this case is $2.2 billion. In the final step, we divide the equity value by the number of shares outstanding. Relative to the current share price of $37.4, the company appears roughly fairly valued at a 6.7% discount to the current share price. However, valuations are imprecise instruments, much like a telescope – move a few degrees and you end up in another galaxy. Keep this in mind.

The assumptions

We would like to point out that the key inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is making your own assessment of a company’s future performance, so try the calculation yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or a company’s future capital needs and therefore does not provide a complete picture of a company’s potential performance. Since we consider Sapiens International 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 8.0%, which is based on a leveraged beta of 1.004. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies with an imposed limit of between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT analysis for Sapiens International

Looking ahead:

Although the valuation of a company is important, ideally it should not be the only analysis you look at for a company. The DCF model is not a perfect stock valuation tool. It should be viewed more as a guide to “what assumptions must hold for this stock to be under/overvalued”. If a company grows differently or its cost of equity or risk-free rate changes significantly, the outcome can be very different. For Sapiens International, we have compiled three relevant factors for you to consider:

1. Risks: You should be aware 1 warning signal for Sapiens International we uncovered before considering investing in the company.
2. Future income: How is SPNS’ growth rate compared to competitors and the overall market? Learn more about analyst consensus numbers for the coming years by using our free chart of analyst growth expectations.
3. Other solid companies: Low debt, high returns on equity, and good past performance are the foundation of a strong company. Check out our interactive list of stocks with solid business fundamentals to see if there are any other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every American stock daily, so if you want to find out the intrinsic value of another stock, just search here.

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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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