AudioEye, Inc.'s (NASDAQ:AEYE) Intrinsic Value Is Potentially 18% Below Its Share Price

Key Insights

• The projected fair value for AudioEye is US$10.20 based on 2 Stage Free Cash Flow to Equity

• AudioEye's US$12.46 share price signals that it might be 22% overvalued

• The US$14.67 analyst price target for AEYE is 44% more than our estimate of fair value

Does the April share price for AudioEye, Inc. (NASDAQ:AEYE) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for AudioEye

Step By Step Through The Calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$1.60m	US$2.66m	US$3.53m	US$4.37m	US$5.13m	US$5.78m	US$6.34m	US$6.81m	US$7.21m	US$7.56m
Growth Rate Estimate Source	Analyst x1	Analyst x1	Est @ 32.88%	Est @ 23.71%	Est @ 17.28%	Est @ 12.78%	Est @ 9.64%	Est @ 7.43%	Est @ 5.89%	Est @ 4.81%
Present Value ($, Millions) Discounted @ 6.9%	US$1.5	US$2.3	US$2.9	US$3.3	US$3.7	US$3.9	US$4.0	US$4.0	US$3.9	US$3.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$33m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 6.9%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$7.6m× (1 + 2.3%) ÷ (6.9%– 2.3%) = US$167m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$167m÷ ( 1 + 6.9%)¹⁰= US$85m

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$119m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$12.5, the company appears slightly overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 AudioEye 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 6.9%, which is based on a levered beta of 1.007. 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.

SWOT Analysis for AudioEye

Strength

• Cash in surplus of total debt.

Weakness

• Expensive based on P/S ratio and estimated fair value.

Opportunity

• Forecast to reduce losses next year.

• Has sufficient cash runway for more than 3 years based on current free cash flows.

Threat

• Debt is not well covered by operating cash flow.

• Not expected to become profitable over the next 3 years.

Next Steps:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. 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 dramatically alter the overall result. What is the reason for the share price exceeding the intrinsic value? For AudioEye, we've compiled three important items you should look at:

1. Risks: You should be aware of the 2 warning signs for AudioEye we've uncovered before considering an investment in the company.

2. Future Earnings: How does AEYE'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 NASDAQCM every day. If you want to find the calculation for other stocks just search here.

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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.