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Strategic Education, Inc. (NASDAQ:STRA) Shares Could Be 41% Below Their Intrinsic Value Estimate

Key Insights

  • The projected fair value for Strategic Education is US$164 based on 2 Stage Free Cash Flow to Equity

  • Strategic Education is estimated to be 41% undervalued based on current share price of US$96.59

  • The US$99.75 analyst price target for STRA is 39% less than our estimate of fair value

Does the January share price for Strategic Education, Inc. (NASDAQ:STRA) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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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See our latest analysis for Strategic Education

The Method

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 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.

A DCF is all about the idea that a dollar in the future is less valuable 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) estimate

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF ($, Millions)

US$101.7m

US$131.8m

US$154.6m

US$174.3m

US$191.0m

US$205.1m

US$217.1m

US$227.4m

US$236.5m

US$244.7m

Growth Rate Estimate Source

Analyst x1

Analyst x1

Est @ 17.28%

Est @ 12.76%

Est @ 9.60%

Est @ 7.39%

Est @ 5.84%

Est @ 4.75%

Est @ 3.99%

Est @ 3.46%

Present Value ($, Millions) Discounted @ 6.9%

US$95.1

US$115

US$126

US$133

US$137

US$137

US$136

US$133

US$129

US$125

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.3b

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 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 6.9%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$245m× (1 + 2.2%) ÷ (6.9%– 2.2%) = US$5.3b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$5.3b÷ ( 1 + 6.9%)10= US$2.7b

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$4.0b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$96.6, the company appears quite undervalued at a 41% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
dcf

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 Strategic Education 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 6.9%, which is based on a levered beta of 0.945. 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 Strategic Education

Strength

  • Debt is not viewed as a risk.

Weakness

  • Earnings declined over the past year.

  • Dividend is low compared to the top 25% of dividend payers in the Consumer Services market.

Opportunity

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

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

Threat

  • Dividends are not covered by earnings and cashflows.

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

Looking Ahead:

Valuation is only one side of the coin in terms of building your investment thesis, and it 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. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" 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 Strategic Education, there are three pertinent factors you should assess:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Strategic Education , and understanding this should be part of your investment process.

  2. Future Earnings: How does STRA'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS 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.