Fathom Digital Manufacturing Corporation’s (NYSE:FATH) Intrinsic Value Is Potentially 54% Above Its Share Price


Today we will run through one way of estimating the intrinsic value of Fathom Digital Manufacturing Corporation (NYSE:FATH) by taking the forecast future cash flows of the company and discounting them back to today’s value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it’s not too difficult to follow, as you’ll see from our example!

We generally believe that a company’s value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Fathom Digital Manufacturing

The model

We’re using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, 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 the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today’s value:

10-year free cash flow (FCF) estimate

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$33.6m

US$35.9m

US$37.6m

US$39.1m

US$40.4m

US$41.6m

US$42.7m

US$43.8m

US$44.8m

US$45.7m

Growth Rate Estimate Source

Analyst x1

Analyst x1

Est @ 4.84%

Est @ 3.97%

Est @ 3.36%

Est @ 2.93%

Est @ 2.64%

Est @ 2.43%

Est @ 2.28%

Est @ 2.18%

Present Value ($, Millions) Discounted @ 6.6%

US$31.5

US$31.6

US$31.0

US$30.3

US$29.3

US$28.3

US$27.2

US$26.2

US$25.1

US$24.0

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$284m

The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country’s GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (1.9%) 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%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$46m × (1 + 1.9%) ÷ (6.6%– 1.9%) = US$991m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$991m÷ ( 1 + 6.6%)10= US$521m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$805m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$3.9, the company appears quite undervalued at a 35% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula – garbage in, garbage out.

dcf

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Part of investing is coming up with your own evaluation of a company’s future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company’s future capital requirements, so it does not give a full picture of a company’s potential performance. Given that we are looking at Fathom Digital Manufacturing 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 accounts for debt. In this calculation we’ve used 6.6%, which is based on a levered beta of 1.110. Beta is a measure of a stock’s volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Although the valuation of a company is important, it ideally won’t be the sole piece of analysis you scrutinize for a company. It’s not possible to obtain a foolproof valuation with a DCF model. Preferably you’d apply different cases and assumptions and see how they would impact the company’s valuation. For instance, if the terminal value growth rate is adjusted slightly, it can alter the overall result. Why is the intrinsic value higher than the current share price? For Fathom Digital Manufacturing, we’ve compiled three further factors you should look at:

  1. Risks: Be aware that Fathom Digital Manufacturing is showing 3 warning signs in our investment analysis and 1 of those is a bit concerning…

  2. Future Earnings: How does FATH’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.

  3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app conducts 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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