Is There An Opportunity With Compugen Ltd.'s (NASDAQ:CGEN) 33% Undervaluation?
Key Insights
- Using the 2 Stage Free Cash Flow to Equity, Compugen fair value estimate is US$1.77
- Current share price of US$1.18 suggests Compugen is potentially 33% undervalued
- Our fair value estimate is 56% lower than Compugen's analyst price target of US$4.00
How far off is Compugen Ltd. (NASDAQ:CGEN) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.
Is Compugen Fairly Valued?
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
| 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
| Levered FCF ($, Millions) | US$4.88m | US$7.92m | US$1.19m | US$240.0k | US$9.92m | US$10.7m | US$11.4m | US$12.0m | US$12.6m | US$13.1m |
| Growth Rate Estimate Source | Analyst x1 | Analyst x1 | Analyst x1 | Analyst x1 | Analyst x1 | Est @ 8.16% | Est @ 6.53% | Est @ 5.40% | Est @ 4.60% | Est @ 4.05% |
| Present Value ($, Millions) Discounted @ 8.1% | US$4.5 | US$6.8 | US$0.9 | US$0.2 | US$6.7 | US$6.7 | US$6.6 | US$6.4 | US$6.2 | US$6.0 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$51m
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 2.8%. We discount the terminal cash flows to today's value at a cost of equity of 8.1%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$13m× (1 + 2.8%) ÷ (8.1%– 2.8%) = US$250m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$250m÷ ( 1 + 8.1%)10= US$114m
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$165m. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$1.2, the company appears quite good value at a 33% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
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. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Compugen 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 8.1%, which is based on a levered beta of 0.834. 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.
View our latest analysis for Compugen
SWOT Analysis for Compugen
- Currently debt free.
- No major weaknesses identified for CGEN.
- Forecast to reduce losses next year.
- Has sufficient cash runway for more than 3 years based on current free cash flows.
- Trading below our estimate of fair value by more than 20%.
- Not expected to become profitable over the next 3 years.
Moving On:
Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. Can we work out why the company is trading at a discount to intrinsic value? For Compugen, we've put together three additional aspects you should further examine:
- Risks: Case in point, we've spotted 3 warning signs for Compugen you should be aware of, and 1 of them is significant.
- Future Earnings: How does CGEN'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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock 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.