Are Natera, Inc. (NASDAQ: NTRA) Investors Paying Above Embedded Value?

Today we’re going to walk through one way to estimate the intrinsic value of Natera, Inc. (NASDAQ: NTRA) by taking expected future cash flows and discounting them to present value. The DCF (Discounted Cash Flow) model is the tool we will apply to do this. Patterns like these may seem beyond a layman’s comprehension, but they are easy enough to follow.

We would like to point out that there are many ways to assess a business, and like DCF, each technique has advantages and disadvantages in certain scenarios. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.

Check out our latest review for Natera

Step by step in the calculation

We are going to use a two-step DCF model which, as the name suggests, takes into account two growth stages. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “steady growth”. To begin with, we need to estimate the next ten years of cash flow. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous Free Cash Flow (FCF) from the last estimate or last published value. We assume that companies with decreasing free cash flow will slow their withdrawal rate, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect that growth tends to slow down more in the early years than in the following years.

Typically, 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 the present value:

10-year Free Cash Flow (FCF) forecast

(“East” = FCF growth rate estimated by Simply Wall St)
10 year present value of cash flow (PVCF) = 1.4 billion USD

After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. Gordon’s growth formula is used to calculate the terminal value at a future annual growth rate equal to the five-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to their present value at a cost of equity of 7.5%.

Terminal value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = $ 625 million × (1 + 2.0%) ÷ (7.5% – 2.0%) = $ 12 billion

Present value of terminal value (PVTV)= TV / (1 + r)^ten= $ 12 billion ÷ (1 + 7.5%)^ten= 5.6 billion USD

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is US $ 7.0 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of US $ 107, the company looks potentially overvalued at the time of writing. Remember though, this is only a rough estimate, and like any complex formula – garbage in, garbage out.

The hypotheses

The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. Part of investing is making your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we view Natera 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 takes into account debt. In this calculation, we used 7.5%, which is based on a leveraged beta of 1.053. Beta is a measure of the volatility of a stock, relative 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.

Looking forward:

While important, the DCF calculation ideally won’t be the only analysis you look at for a business. DCF models are not the ultimate investment valuation solution. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. Why is intrinsic value lower than the current share price? For Natera, we’ve put together three relevant things you should consider:

1. Risks: You should be aware of the 3 warning signs for Natera we found out before considering an investment in the business.
2. Management: Have insiders increased their stocks to take advantage of market sentiment for NTRA’s future outlook? Check out our management and board analysis with information on CEO compensation and governance factors.
3. Other strong companies: Low debt, high returns on equity, and good past performance are essential to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app performs a daily discounted cash flow assessment for each NASDAQGS share. If you want to find the calculation for other actions, just search here.

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This Simply Wall St article is general in nature. It is not a recommendation to buy or sell stocks, and does not take into account your goals or your financial situation. We aim to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative information. Simply Wall St has no position in any of the stocks mentioned.
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