JFrog Ltd. (NASDAQ:FROG) shares could be 23% above their estimated intrinsic value

Key findings

• The projected fair value for JFrog is $30.74 based on 2-step Free Cash Flow to Equity
• The current share price of $37.87 suggests that JFrog may be overvalued by 23%
• The analyst price target of $46.50 for FROG is 51% above our fair value estimate

Does JFrog Ltd. (NASDAQ:FROG)’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. Our analysis will use the Discounted Cash Flow (DCF) model. Don’t be put off by the technical jargon, the math behind it is actually quite simple.

We would like to point out that there are many ways to value a company and that each method, like the DCF, has advantages and disadvantages in certain scenarios. If you still have questions about this type of valuation, take a look at Simply Wall St’s analysis model.

Check out our latest analysis for JFrog

The calculation

We use a two-stage DCF model which, as the name suggests, considers two phases of growth. The first stage is generally a higher growth phase that stabilizes toward the terminal value captured in the second “steady growth” stage. First, we need to estimate the next ten years of cash flows. Where possible, we use analyst estimates, but when these aren’t available, we extrapolate 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:

10-year free cash flow (FCF) forecast

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 1.1 billion US dollars

We now need to calculate the terminal value that takes into account 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 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 6.9%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = $196 million × (1 + 2.4%) ÷ (6.9% – 2.4%) = $4.4 billion

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 4.4 billion US dollars ÷ ( 1 + 6.9 %)¹⁰= 2.2 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 $3.3 billion. The final step is to divide the equity value by the number of shares outstanding. Relative to the current share price of $37.9, the company appears slightly overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it’s better to consider this a rough estimate that isn’t accurate to the last penny.

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. 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 JFrog 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 6.9%, which is based on a leveraged beta of 0.993. 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 JFrog

Next Steps:

While important, the DCF calculation should not be the only metric you consider when researching a company. DCF models are not the be-all and end-all of investment valuation. Rather, they should be viewed as a guide to “what assumptions need to hold for this stock to be under/overvalued.” For example, changes in the company’s cost of equity or risk-free interest rate can significantly affect the valuation. Can we figure out why the company is trading at a premium to intrinsic value? For JFrog, there are three other elements you should investigate further:

1. Risks: For example, we found 3 warning signs for JFrog that you should know before investing here.
2. management:Have insiders increased their shares to capitalize on market sentiment regarding FROG’s future prospects? Read our management and board analysis with insights into CEO compensation and governance factors.
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 NASDAQGS 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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