Is JFrog Ltd. (NASDAQ:FROG) Expensive For A Reason? A Look At Its Intrinsic Value
Key Insights
Using the 2 Stage Free Cash Flow to Equity, JFrog fair value estimate is US$25.20
Current share price of US$32.53 suggests JFrog is potentially 29% overvalued
The US$37.20 analyst price target for FROG is 48% more than our estimate of fair value
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of JFrog Ltd. (NASDAQ:FROG) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
View our latest analysis for JFrog
The Model
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$73.0m | US$93.7m | US$109.4m | US$122.9m | US$134.3m | US$143.9m | US$152.1m | US$159.2m | US$165.5m | US$171.1m |
Growth Rate Estimate Source | Analyst x10 | Analyst x6 | Est @ 16.69% | Est @ 12.35% | Est @ 9.31% | Est @ 7.18% | Est @ 5.69% | Est @ 4.65% | Est @ 3.92% | Est @ 3.41% |
Present Value ($, Millions) Discounted @ 7.2% | US$68.1 | US$81.6 | US$88.8 | US$93.1 | US$95.0 | US$95.0 | US$93.6 | US$91.4 | US$88.7 | US$85.5 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$881m
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.2%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.2%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$171m× (1 + 2.2%) ÷ (7.2%– 2.2%) = US$3.5b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$3.5b÷ ( 1 + 7.2%)10= US$1.8b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$2.6b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$32.5, the company appears slightly overvalued at the time of writing. 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.
Important Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 JFrog 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 7.2%, which is based on a levered beta of 0.992. 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.
SWOT Analysis for JFrog
Strength
Currently debt free.
Weakness
Expensive based on P/S ratio and estimated fair value.
Shareholders have been diluted in the past year.
Opportunity
Forecast to reduce losses next year.
Has sufficient cash runway for more than 3 years based on current free cash flows.
Threat
Not expected to become profitable over the next 3 years.
Moving On:
Whilst important, the DCF calculation 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. What is the reason for the share price exceeding the intrinsic value? For JFrog, there are three pertinent aspects you should further research:
Risks: Case in point, we've spotted 3 warning signs for JFrog you should be aware of.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for FROG's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
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.