Veracyte, Inc. (NASDAQ:VCYT)’s intrinsic value may be 76% higher than its share price

Key findings

• The projected fair value for Veracyte is $37.52 based on 2-step free cash flow to equity
• Veracyte’s share price of $21.33 suggests the company may be undervalued by 43%
• The analyst price target of $29.83 for VCYT is 20% below our fair value estimate

In this article, we will estimate the intrinsic value of Veracyte, Inc. (NASDAQ:VCYT) by estimating the company’s future cash flows and discounting them to their present value using the Discounted Cash Flow (DCF) model. Models like this may seem incomprehensible to a layperson, but they are relatively easy to follow.

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 it is not without its flaws. If you want to learn more about discounted cash flow, you can read the basics of this calculation in detail in Simply Wall St’s analysis model.

Check out our latest analysis for Veracyte

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 all about the idea that a dollar in the future is worth less than a dollar today. Therefore, we need to discount the sum of these future cash flows to arrive at an estimate of present 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) = 731 million US dollars

After calculating the present value of future cash flows in the first 10-year period, we need to calculate the terminal value that takes into account all future cash flows after the first period. 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 6.2%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = 147 million US dollars × (1 + 2.4%) ÷ (6.2% – 2.4%) = 3.9 billion US dollars

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 3.9 billion US dollars ÷ (1 + 6.2%)¹⁰= 2.1 billion 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 $2.9 billion. To get the intrinsic value per share, we divide that by the total number of shares outstanding. Relative to the current share price of $21.3, the company seems to offer pretty good value for money at a 43% 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 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 potential 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 are viewing Veracyte 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 6.2%, which is based on a leveraged beta of 0.835. 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 a set limit between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT Analysis for Veracyte

Looking ahead:

Although valuing 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 tool for stock valuation. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to an undervaluation or overvaluation of the company. For example, changes in the company’s cost of equity or risk-free interest rate can significantly affect the valuation. What is the reason for the stock price being below the intrinsic value? For Veracyte, we have compiled three relevant aspects that you should investigate further:

1. Risks: For example, we found 1 warning signal for Veracyte that you should know.
2. Future income: How is VCYT’s 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 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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