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Is There An Opportunity With Masimo Corporation's (NASDAQ:MASI) 24% Undervaluation?

Key Insights

  • Masimo's estimated fair value is US$181 based on 2 Stage Free Cash Flow to Equity

  • Current share price of US$138 suggests Masimo is potentially 24% undervalued

  • Analyst price target for MASI is US$148 which is 18% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Masimo Corporation (NASDAQ:MASI) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. It may sound complicated, but actually it is quite simple!

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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See our latest analysis for Masimo

What's The Estimated Valuation?

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF ($, Millions)

US$176.1m

US$346.8m

US$394.1m

US$429.3m

US$459.0m

US$484.4m

US$506.5m

US$526.2m

US$544.1m

US$560.8m

Growth Rate Estimate Source

Analyst x3

Analyst x2

Analyst x2

Est @ 8.92%

Est @ 6.93%

Est @ 5.54%

Est @ 4.56%

Est @ 3.88%

Est @ 3.40%

Est @ 3.07%

Present Value ($, Millions) Discounted @ 6.8%

US$165

US$304

US$323

US$330

US$330

US$326

US$319

US$311

US$301

US$290

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$3.0b

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 (2.3%) 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 6.8%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$561m× (1 + 2.3%) ÷ (6.8%– 2.3%) = US$13b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$13b÷ ( 1 + 6.8%)10= US$6.6b

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$9.6b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$138, the company appears a touch undervalued at a 24% 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.

dcf
dcf

Important Assumptions

Now 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 Masimo 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 6.8%, which is based on a levered beta of 0.982. 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 Masimo

Strength

  • Debt is well covered by earnings.

Weakness

  • Earnings declined over the past year.

Opportunity

  • Annual earnings are forecast to grow faster than the American market.

  • Trading below our estimate of fair value by more than 20%.

Threat

  • Debt is not well covered by operating cash flow.

  • Annual revenue is forecast to grow slower than the American market.

Next Steps:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. 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. What is the reason for the share price sitting below the intrinsic value? For Masimo, we've put together three essential factors you should further examine:

  1. Risks: Take risks, for example - Masimo has 2 warning signs (and 1 which is concerning) we think you should know about.

  2. Future Earnings: How does MASI'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.

  3. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.