Shopify Inc. (NYSE:SHOP) Shares Could Be 31% Above Their Intrinsic Value Estimate

Key Insights

• The projected fair value for Shopify is US$48.19 based on 2 Stage Free Cash Flow to Equity

• Shopify's US$63.01 share price signals that it might be 31% overvalued

• Analyst price target for SHOP is US$67.88, which is 41% above our fair value estimate

In this article we are going to estimate the intrinsic value of Shopify Inc. (NYSE:SHOP) by taking the forecast future cash flows of the company and discounting them back to today's 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 still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Shopify

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 begin with, we have to get estimates of 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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$879.5m	US$1.30b	US$1.74b	US$2.41b	US$2.93b	US$3.39b	US$3.78b	US$4.12b	US$4.40b	US$4.64b
Growth Rate Estimate Source	Analyst x21	Analyst x10	Analyst x7	Analyst x7	Est @ 21.58%	Est @ 15.75%	Est @ 11.67%	Est @ 8.81%	Est @ 6.81%	Est @ 5.42%
Present Value ($, Millions) Discounted @ 7.5%	US$818	US$1.1k	US$1.4k	US$1.8k	US$2.0k	US$2.2k	US$2.3k	US$2.3k	US$2.3k	US$2.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$19b

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 (2.2%) 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 7.5%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$4.6b× (1 + 2.2%) ÷ (7.5%– 2.2%) = US$89b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$89b÷ ( 1 + 7.5%)¹⁰= US$43b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$62b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$63.0, the company appears potentially 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

The Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 Shopify 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 7.5%, which is based on a levered beta of 1.065. 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 Shopify

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.

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value lower than the current share price? For Shopify, we've compiled three fundamental items you should consider:

1. Financial Health: Does SHOP have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SHOP's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

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.

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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.