Estimating the intrinsic value of Arista Networks, Inc. (NYSE:ANET)

Key findings

• The projected fair value for Arista Networks is $377 based on 2-step free cash flow to equity

• With a share price of $331, Arista Networks appears to be trading close to its estimated fair value

• Our fair value estimate is 12% above Arista Networks’ analyst price target of $337.

How far is Arista Networks, Inc. (NYSE:ANET) from its intrinsic value? Using the most recent financial data, we will check whether the stock is fairly valued. To do this, we will take the company’s projected future cash flows and discount them to today’s value using the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too difficult to follow, as you’ll see from our example!

However, keep in mind that there are many ways to estimate the value of a company, and a DCF is just one of them. If you want to learn more about intrinsic value, you should check out Simply Wall St’s analysis model.

Check out our latest analysis for Arista Networks

Step by step through the calculation

We use a two-stage DCF model which, as the name suggests, considers two stages of growth. The first stage is generally a period of higher growth that stabilizes towards the terminal value, which is captured in the second stage of “steady growth”. The first stage requires us to estimate the company’s cash flows for 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 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:

The story goes on

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) = 36 billion 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 6.6%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = 6.5 billion US dollars × (1 + 2.4%) ÷ (6.6% – 2.4%) = 156 billion US dollars

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 156 billion US dollars ÷ ( 1 + 6.6 %)¹⁰= 82 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 $118 billion. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of $331, the company appears to be about fair value, at a 12% discount to the current share price. However, keep in mind that this is only an approximate valuation and as with any complex formula, where there’s garbage in, there’s garbage out.

Important 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. If you disagree with these results, try the calculation yourself and play with the 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 Arista Networks 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 6.6%, which is based on a leveraged beta of 0.919. 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 Arista Networks

Strength

weakness

Opportunity

Danger

Looking ahead:

While a company’s valuation is important, it is only one of many factors you need to evaluate a company. The DCF model is not a perfect stock valuation tool. It should be viewed more as a guide to “what assumptions need to hold for this stock to be under/overvalued.” For example, making a small adjustment to the terminal value growth rate can dramatically change the overall result. For Arista Networks, we have compiled three additional points for you to further investigate:

1. Risks: For example, we found 1 warning signal for Arista Networks that you need to consider before investing here.

2. Future income: How is ANET’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 high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get an idea of ​​what else you might be missing out on!

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.

Do you have feedback on this article? Are you concerned about the content? Get in touch directly from us. Alternatively, send an email to editorial-team (at) simplywallst.com.

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.

Do you have feedback on this article? Are you interested in the content? Contact us directly. Alternatively, send an email to [email protected]