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Salesforce, Inc.'s (NYSE:CRM) Intrinsic Value Is Potentially 45% Above Its Share Price

Key Insights

  • The projected fair value for Salesforce is US$421 based on 2 Stage Free Cash Flow to Equity

  • Current share price of US$290 suggests Salesforce is potentially 31% undervalued

  • The US$291 analyst price target for CRM is 31% less than our estimate of fair value

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Salesforce, Inc. (NYSE:CRM) 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. Believe it or not, it's not too difficult to follow, as you'll see from our example!

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. 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.

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Check out our latest analysis for Salesforce

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. 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) estimate

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF ($, Millions)

US$8.52b

US$10.4b

US$12.1b

US$14.9b

US$17.0b

US$19.8b

US$21.8b

US$23.5b

US$25.0b

US$26.3b

Growth Rate Estimate Source

Analyst x25

Analyst x24

Analyst x17

Analyst x3

Analyst x3

Analyst x2

Est @ 10.32%

Est @ 7.91%

Est @ 6.22%

Est @ 5.04%

Present Value ($, Millions) Discounted @ 7.0%

US$8.0k

US$9.1k

US$9.9k

US$11.4k

US$12.1k

US$13.2k

US$13.6k

US$13.7k

US$13.6k

US$13.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$118b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 7.0%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$26b× (1 + 2.3%) ÷ (7.0%– 2.3%) = US$570b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$570b÷ ( 1 + 7.0%)10= US$289b

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$407b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$290, the company appears quite good value at a 31% 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

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Salesforce 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 7.0%, which is based on a levered beta of 1.025. 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 Salesforce

Strength

  • Earnings growth over the past year exceeded the industry.

  • Debt is not viewed as a risk.

Weakness

  • No major weaknesses identified for CRM.

Opportunity

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

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

Threat

  • Revenue is forecast to grow slower than 20% per year.

Looking Ahead:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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. Why is the intrinsic value higher than the current share price? For Salesforce, we've compiled three relevant aspects you should look at:

  1. Risks: For instance, we've identified 2 warning signs for Salesforce that you should be aware of.

  2. Future Earnings: How does CRM'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 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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks 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.