Today, we’ll walk through one way to estimate the intrinsic value of ANSYS, Inc. (NASDAQ:ANSS) by estimating the company’s future cash flows and discounting them to their present value. On this occasion, we will use the Discounted Cash Flow (DCF) model. Don’t be put off by the jargon, the underlying calculations are actually quite simple.

Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St Analysis Template.

Discover our latest analysis for ANSYS

## What is the estimated value?

We use what is called a 2-step model, which simply means that we have two different periods of company cash flow growth rates. Generally, the first stage is a higher growth phase and the second stage is a lower growth phase. To start, we need to estimate the cash flows for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.

A DCF is based on the idea that a dollar in the future is worth less 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

 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 Leveraged FCF (\$, millions) \$662.2 million \$773.3 million \$939.5 million \$1.08 billion \$1.18 billion \$1.27 billion \$1.34 billion \$1.40 billion \$1.45 billion \$1.50 billion Growth rate estimate Source Analyst x11 Analyst x7 Analyst x2 Analyst x1 Is 9.55% Is at 7.26% Is at 5.67% Is at 4.55% Is at 3.77% Is at 3.22% Present value (millions of dollars) discounted at 6.3% \$623 \$684 \$782 \$845 \$871 \$879 \$873 \$859 \$838 \$814

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = \$8.1 billion

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 stage. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.9%. We discount terminal cash flows to present value at a cost of equity of 6.3%.

Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = \$1.5 billion × (1 + 1.9%) ÷ (6.3%–1.9%) = \$35 billion

Present value of terminal value (PVTV)= TV / (1 + r)ten= \$35 billion ÷ (1 + 6.3%)ten= \$19 billion

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is \$27 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of US\$218, the company looks slightly undervalued at a 30% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.

## Important assumptions

We emphasize 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 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, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider ANSYS 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 debt into account. In this calculation, we used 6.3%, which is based on a leveraged beta of 1.032. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

## Next steps:

Although the valuation of a business is important, it will ideally not be the only piece of analysis you will look at for a business. The DCF model is not a perfect stock valuation tool. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under/overvalued?” For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. Why is intrinsic value higher than the current stock price? For ANSYS, we have put together three relevant factors that you should dig deeper into:

1. Financial health: Does the ANSS have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors such as leverage and risk.
2. Future earnings: How does the ANSS growth rate compare to its peers and the wider market? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
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 strong trading fundamentals to see if there are any other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every US stock daily, so if you want to find the intrinsic value of any other stock, do a search here.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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