Calculating the intrinsic value of elf Beauty, Inc. (NYSE:ELF)

key insights

• Elf Beauty’s expected fair value is US$192 based on two-stage free cash flows to equity.

• elf Beauty’s share price of $186 indicates it is trading at a level similar to its fair value estimate

• Our fair value estimate is 4.1% lower than elf Beauty’s analyst price target of $200

Does Elf Beauty Inc. (NYSE:ELF)’s February stock price reflect its actual value? Today we’ll estimate the company’s future cash flows and discount them to their present value. Estimate the intrinsic value of . The discounted cash flow (DCF) model is the tool we apply to do this. Don’t be put off by the jargon. The math behind it is actually quite simple.

We generally think of a company’s value as the present value of all the cash it will generate in the future. However, DCF is just one metric among many, and it is not without its flaws. If you still have doubts about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis on elf beauty.

Method

As the name suggests, we use a two-stage DCF model that considers two stages of growth. The first stage is typically a period of higher growth, leveling off towards terminal value, which is captured by a second period of ‘steady growth’. First, you need to obtain an estimate of your cash flows for the next 10 years. 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 that companies with shrinking free cash flow will see their rate of shrinkage slow, and companies with growing free cash flow will see their growth rate slow over this period. This is to reflect that growth tends to be slower in the early years than in later years.

It is generally assumed that a dollar today is worth more than a dollar in the future, so the sum of these future cash flows is discounted to today’s value.

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10-year free cash flow (FCF) forecast

(“Est” = FCF growth rate estimated by Simply Wall St)
Present value of cash flows over 10 years (PVCF) = USD 3.1 billion

After calculating the present value of the first 10 years of future cash flows, you need to calculate the final value, which takes into account all future cash flows from the first stage onwards. For various reasons, a very conservative growth rate is used that cannot exceed the country’s GDP growth rate. In this case, we used the five-year average of the 10-year Treasury yield (2.3%) to estimate future growth. Similar to the 10-year “growth” period, we use a cost of capital of 7.2% to discount future cash flows to their present value.

Terminal value (TV)=FCF₂₀₃₃ × (1 + g) ÷ (r – g) = USD 727 million × (1 + 2.3%) ÷ (7.2% – 2.3%) = USD 15 billion

Present Value of Terminal Value (PVTV)= TV / (1 + r)^Ten= USD 15 billion ÷ ( 1 + 7.2%)^Ten= USD 7.6 billion

The total value is the sum of the cash flows over the next 10 years plus the discounted terminal value, resulting in a total equity value, which in this case is USD 11 billion. To get the intrinsic value per share, divide this by the total number of shares outstanding. Compared to the current share price of $186, the company appears to be at about fair value, which is a 3.1% discount to the current share price. However, keep in mind that this is just a rough estimate and, like any complex formula, there is garbage in and garbage out.

Important prerequisites

The above calculation relies heavily on two assumptions. One is the discount rate and the other is the cash flow. You are not required to agree to these inputs. I encourage you to redo the calculations yourself and give it a try. Additionally, DCF does not give a complete picture of a company’s potential performance because it does not take into account the cyclicality of the industry or the company’s future capital requirements. Given that we are considering elf Beauty as a potential shareholder, cost of capital is used as the discount rate, rather than cost of capital taking into account debt (or weighted average cost of capital, WACC). For this calculation, we used 7.2% based on a leverage beta of 1.066. Beta is a measure of a stock’s volatility compared to the market as a whole. Beta values ​​are derived from industry average beta values ​​for globally comparable companies and are constrained to a range of 0.8 to 2.0, which is a reasonable range for stable businesses.

SWOT Analysis for Elf Beauty

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Valuation is only one side of the coin in building an investment thesis, and ideally it should never be the only analytical element scrutinized about a company. It is not possible to obtain a reliable valuation with the DCF model. If possible, it’s a good idea to apply different cases and assumptions and see how they affect the company’s valuation. For example, a small adjustment to the terminal value growth rate can dramatically change the overall result. He summarized three important aspects of elf beauty that should be appreciated.

1. risk: For example, I discovered the following: Two warning signs for elf beauty What you need to know before investing here.

2. management:Are insiders capitalizing on market sentiment regarding ELF’s future prospects by buying more shares? View our management team and board analysis with insights into CEO compensation and governance factors.

3. Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of quality stocks to figure out what else you’re missing.

PS. The Simply Wall St app provides daily discounted cash flow valuations for all NYSE stocks. If you want to know the calculations for other stocks, please 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 using only unbiased methodologies, and the articles are not intended as financial advice. This is not a recommendation to buy or sell any stock, and does not take into account your objectives or financial situation. We aim to provide long-term, focused analysis based on fundamental data. Note that our analysis may not factor in the latest announcements or qualitative material from price-sensitive companies. Simply Wall St has no position in any stocks mentioned.