Aspen Technology, Inc. (NASDAQ: AZPN) Intrinsic Value Is Potentially 25% Less Than Its Stock Price

Does Aspen Technology, Inc.’s (NASDAQ: AZPN) share price in May reflect what it is really worth? Today we’re going to estimate the intrinsic value of the stock by taking expected future cash flows and discounting them to present value. This will be done using the Discounted Cash Flow (DCF) model. There really isn’t much, although it may seem quite complex.

There are many ways that businesses can be valued, so we would like to stress that a DCF is not perfect for all situations. If you would like to know more about discounted cash flows, the rationale for this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest review of Aspen technology

The model

We use the 2-step growth model, which simply means that we take into account two stages of business growth. During the initial period, the business can have a higher growth rate and the second stage is usually assumed to have a stable growth rate. First, we need to estimate the cash flow of the business over the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or the last reported value. We assume that companies with decreasing free cash flow will slow their withdrawal rate, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect that growth tends to slow down more in the early years than in the later years.

Typically, we assume that a dollar today is worth more than a dollar in the future, so we discount the value of those future cash flows to their estimated value in today’s dollars:

10-year Free Cash Flow (FCF) forecast

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = 2.5 billion USD

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 step. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to their present value at a cost of equity of 6.4%.

Terminal value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = $ 407 million × (1 + 2.0%) ÷ (6.4% – 2.0%) = $ 9.3 billion

Present value of terminal value (PVTV)= TV / (1 + r)^ten= 9.3 billion USD ÷ (1 + 6.4%)^ten= 5.0 billion USD

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is US $ 7.5 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of US $ 146, the company appears reasonably expensive at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it’s best to think of this as a rough estimate, not precise down to the last penny.

Important assumptions

Now the most important data for a discounted cash flow is the discount rate and, of course, the actual cash flow. If you don’t agree with these results, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we view Aspen Technology 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 into account debt. In this calculation, we used 6.4%, which is based on a leveraged beta of 0.943. Beta is a measure of the volatility of a stock, relative 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.

Looking forward:

While a business valuation is important, ideally it won’t be the only analysis you review for a business. DCF models are not the alpha and omega of investment valuation. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. Why is intrinsic value lower than the current share price? For Aspen Technology, there are three additional things you need to assess:

1. Risks: For example, we discovered 2 warning signs for Aspen technology (1 cannot be ignored!) Which you should be aware of before investing here.
2. Future income: How does AZPN’s growth rate compare to its peers and the market in general? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth forecast chart.
3. Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high quality inventory to get a feel for what you might be missing!

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

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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. We aim to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative information. Simply Wall St has no position in any of the stocks mentioned.
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