A look at the fair value of Palantir Technologies Inc. (NYSE: PLTR)
Today we’ll walk through one way to estimate the intrinsic value of Palantir Technologies Inc. (NYSE: PLTR) by taking expected future cash flows and discounting them to the present value. This will be done using the discounted cash flow (DCF) model. Patterns like these may seem beyond a layman’s comprehension, but they’re pretty 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 of many evaluation metrics, and it is not without its flaws. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.
Check out our latest analysis for Palantir Technologies
The model
We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. To begin with, we need to obtain cash flow estimates for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.
Generally, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:
Estimated free cash flow (FCF) over 10 years
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leveraged FCF ($, millions) | $366.0 million | US$544.6 million | $685.5 million | $813.6 million | $924.9 million | $1.02 billion | $1.10 billion | $1.16 billion | $1.22 billion | $1.27 billion |
Growth rate estimate Source | Analyst x5 | Analyst x4 | Is at 25.87% | Is at 18.69% | Is at 13.67% | Is at 10.16% | Is at 7.7% | Is 5.98% | Is at 4.77% | Is at 3.93% |
Present value (millions of dollars) discounted at 6.2% | $345 | $483 | $572 | $639 | $684 | $710 | $720 | $718 | $708 | $693 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $6.3 billion
We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 6.2%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = $1.3 billion × (1 + 2.0%) ÷ (6.2%–2.0%) = $30 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= $30 billion ÷ (1 + 6.2%)^{ten}= $17 billion
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is $23 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. From the current share price of US$12.7, the company appears around fair value at the time of writing. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.
Important assumptions
Now, the most important 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 math yourself and play around with the assumptions. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we view Palantir Technologies 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 factors in debt. In this calculation, we used 6.2%, which is based on a leveraged beta of 0.971. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Let’s move on :
While a business valuation is important, it shouldn’t be the only metric to consider when researching a business. DCF models are not the be-all and end-all of investment valuation. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under/overvalued?” For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. For Palantir Technologies, we have put together three fundamental aspects for you to consider:
- Risks: For example, we spotted 4 warning signs for Palantir Technologies you should be aware.
- Management: Did insiders increase their shares to take advantage of market sentiment about PLTR’s future prospects? View our management and board analysis with insights into CEO compensation and governance factors.
- Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality actions to get an idea of what you might be missing!
PS. The Simply Wall St app performs a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks, search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.