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After going through a combination of lockup expiry and uneventful earnings in August, SoFi Technologies, Inc. (NASDAQ: SOFI) held the line at US$14 level. While the stock is still struggling to break above US$16, we can probably agree that it is doing better than expected.
Yet, in the face of the latest rating, we will examine our take on the intrinsic value through the discounted cash flow (DCF) method.
The Latest Outlook
With the worst, arguably, behind the company, it seems like the "perfect storm" didn't do that much damage to the company. While the decline after the earnings was around 13%, that isn't uncommon, especially for the small & medium cap growth companies.
Although the earnings missed (-US$0.48 vs. -US$0.06 expected), these results were heavily skewed by non-cash, one-time expenses. These should not impact companys' fundamentals.
Yet, the company got assigned „only“ a Neutral rating by Credit Suisse, whose analyst Timothy Chiodo stated that he expects the lending operations to subsidize the expansion of Money and Invest products.
However, if the acquisition of Golden Pacific Bancorp goes through in 2021, Sofi could receive full approval for the national bank charter, which will be a positive news catalyst. A national bank charter will allow the company to boost its most valuable segment – lending platform.
Finally, the last event to watch is the expiration of the U.S government student loan relief that expires in January 2022. Although the company could lose up to US$40m in refinancing due to relief, this business segment should pick up through 2022.
Examining the Potential Value
We will use the Discounted Cash Flow (DCF) model on this occasion.
We generally believe that a company's value is the present value of all cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws.
If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
We will use a two-stage DCF model, which, as the name states, considers two stages of growth. The first stage is generally a higher growth period, heading towards the terminal value, captured in the second "steady growth" period.
To start with, we need to estimate the next ten years of cash flows. Where possible, we use analyst estimates, but when these aren't available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage and that companies with growing free cash flow will see their growth rate slow over this period. We do this to reflect that growth tends to slow more in the early years than in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
Levered FCF ($, Millions)
Growth Rate Estimate Source
Est @ -5.59%
Est @ -3.31%
Est @ -1.72%
Est @ -0.61%
Est @ 0.17%
Est @ 0.72%
Present Value ($, Millions) Discounted @ 7.5%
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$18b
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 2.0%. We discount the terminal cash flows to today's value at the cost of equity of 7.5%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r - g) = US$2.5b× (1 + 2.0%) ÷ (7.5%- 2.0%) = US$47b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$47b÷ ( 1 + 7.5%)10= US$23b
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$41b. In the final step, we divide the equity value by the number of shares outstanding.
Relative to the current share price of US$15.3, the company appears potentially underpriced at a discount of over 50%. This might sound concerning, and we recommend potential investors to dig deeper.
What is going on here to cause the market to undervalue the stock so much? The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows.
The DCF 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 its potential performance. Given that we are looking at SoFi Technologies as potential shareholders, the cost of equity is used as the discount rate rather than the cost of capital (or the weighted average cost of capital, WACC), which accounts for debt.
We've used 7.5% in this calculation, which is based on a levered beta of 1.170. 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, a reasonable range for a stable business.
Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool.
Why is the intrinsic value higher than the current share price? Is the market overreacting to the one-time, short-term setbacks and ignoring the positive developments down the road?
For SoFi Technologies, we've put together three fundamental elements you should consider:
Risks: Case in point, we've spotted 2 warning signs for SoFi Technologies you should be aware of.
Future Earnings: How does SOFI'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.
Other High-Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get an idea of what else is out there you may be missing!
PS. The Simply Wall St app conducts 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.
Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article 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.