Calculating the intrinsic value of Proto Labs, Inc. (NYSE:PRLB)

Key findings

• Using the 2-step free cash flow to equity, the fair value estimate of Proto Labs is $42.19.
• The current share price of $34.17 suggests that Proto Labs may be trading close to its fair value
• Analysts’ price target for PRLB is $41.00, 2.8% below our fair value estimate.

How far is Proto Labs, Inc. (NYSE:PRLB) from its intrinsic value? Using the most recent financial data, we will check if the stock is fairly valued by taking the expected future cash flows and discounting them to today’s value using the Discounted Cash Flow (DCF) model. This may sound complicated, but it’s actually quite simple!

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 valuation metric among many and is not without its flaws. For those who enjoy stock analysis, the Simply Wall St analysis model presented here might be of interest.

Check out our latest analysis for Proto Labs

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, the first stage is higher growth and the second stage is a period of lower growth. First, we need to estimate the next ten years of cash flows. Since we don’t have analyst estimates of free cash flow available, we extrapolated the previous free cash flow (FCF) from the company’s last 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:

10-year free cash flow (FCF) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 377 million US dollars

The second phase is also called the terminal value, which is the company’s cash flow after the first phase. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year Treasury yield of 2.4%. We discount the terminal cash flows to today’s value at a cost of equity of 7.0%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = $61 million × (1 + 2.4%) ÷ (7.0% – 2.4%) = $1.4 billion

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= $1.4 billion ÷ (1 + 7.0%)¹⁰= 691 million US dollars

Total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total value of equity, which in this case is $1.1 billion. To get the intrinsic value per share, we divide that by the total number of shares outstanding. Compared to the current share price of $34.2, the company appears to be roughly fairly valued at a 19% 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

The above calculation relies heavily 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 repeating the calculations yourself and playing with them. The DCF also doesn’t take into account the possible cyclicality of an industry or a company’s future capital needs and therefore doesn’t provide a complete picture of a company’s potential performance. Since we consider Proto Labs 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 7.0% 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 Proto Labs

Next Steps:

While the DCF calculation is important, it is only one of many factors you need to evaluate a company. The DCF model is not a perfect tool for stock valuation. The best thing to do is to apply different cases and assumptions and see how they affect the company’s valuation. For example, adjusting the terminal value growth rate slightly can dramatically change the overall result. For Proto Labs, we have compiled three essential elements for you to examine in more detail:

1. Financial health: Does PRLB have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks for key factors such as debt and risk.
2. Future income: How does PRLB’s growth rate compare to its 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. The Simply Wall St app runs a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks, 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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