Unlocking Alarm.com's True Value: A Discounted Cash Flow Analysis
Thursday, Nov 28, 2024 11:09 am ET
4min read Estimating the fair value of a company like Alarm.com Holdings, Inc. (NASDAQ: ALRM) involves a comprehensive analysis of its financial performance, growth prospects, and inherent risks. One popular method for this is the Discounted Cash Flow (DCF) analysis, which takes into account the company's future cash flows and discounts them back to their present value. In this article, we will delve into a DCF analysis of Alarm.com to estimate its fair value.
Alarm.com is a provider of Internet of Things (IoT) and solutions for residential, multi-family, small business, and enterprise commercial markets in North America and internationally. With a strong focus on growth and innovation, the company has seen impressive earnings growth of 84.4% over the past year. However, to determine if Alarm.com's stock price accurately reflects its intrinsic value, we need to analyze its future cash flows.
In a two-stage DCF model, we first estimate the company's free cash flows (FCF) for the next ten years, followed by a terminal value calculation for the subsequent period. Using analyst estimates and historical growth rates, we can project Alarm.com's FCF as follows:
| Year | Levered FCF ($, Millions) | Growth Rate Estimate |
|---|---|---|
| 2025 | 148.5 | 1.45% |
| 2026 | 162.5 | 1.80% |
| 2027 | 147.1 | 2.05% |
| 2028 | 158.6 | 2.22% |
| 2029 | 160.9 | 2.34% |
| 2030 | 163.8 | 2.42% |
| 2031 | 167.1 | 2.42% |
| 2032 | 170.8 | 2.42% |
| 2033 | 174.8 | 2.42% |
| 2034 | 179.1 | 2.42% |
Next, we calculate the terminal value using a conservative growth rate and a suitable discount rate. Assuming a terminal growth rate of 2.6% (the 5-year average of the 10-year government bond yield) and a cost of equity of 6.5% (based on Alarm.com's levered beta of 1.071), the terminal value can be estimated as follows:
Terminal Value (TV) = FCF2034 × (1 + g) / (r – g) = $179.1m × (1 + 2.6%) / (6.5% – 2.6%) = $5.0b
Now, we can sum the present value of the projected cash flows and the terminal value to estimate Alarm.com's fair value:
Fair Value = PVCF + PVTV = $1.1b + $2.7b = $3.8b
To determine the per-share fair value, we divide the total equity value by the number of outstanding shares. Assuming Alarm.com has 104.6 million shares outstanding:
Per-share Fair Value = $3.8b / 104.6 million shares ≈ $36.04
Comparing this estimate to Alarm.com's current stock price of $64.17, we can see that the company appears to be trading at a significant premium to its estimated fair value. However, it is essential to consider the potential risks and uncertainties associated with the DCF analysis and the assumptions made in the projections.
Alarm.com's growth prospects, competitive landscape, and regulatory environment all play a role in its future cash flows. As such, it is crucial for investors to stay informed about these factors and adapt their investment strategies accordingly. Additionally, alternative valuation methods, such as relative valuation or asset-based approaches, can provide a more comprehensive understanding of Alarm.com's fair value.
In conclusion, while the DCF analysis suggests that Alarm.com may be overvalued at its current stock price, investors should consider other factors and perform their own analysis before making investment decisions. By thoroughly evaluating a company's fundamentals, growth prospects, and risks, investors can make more informed decisions and potentially identify undervalued opportunities in the market.
Alarm.com is a provider of Internet of Things (IoT) and solutions for residential, multi-family, small business, and enterprise commercial markets in North America and internationally. With a strong focus on growth and innovation, the company has seen impressive earnings growth of 84.4% over the past year. However, to determine if Alarm.com's stock price accurately reflects its intrinsic value, we need to analyze its future cash flows.
In a two-stage DCF model, we first estimate the company's free cash flows (FCF) for the next ten years, followed by a terminal value calculation for the subsequent period. Using analyst estimates and historical growth rates, we can project Alarm.com's FCF as follows:
| Year | Levered FCF ($, Millions) | Growth Rate Estimate |
|---|---|---|
| 2025 | 148.5 | 1.45% |
| 2026 | 162.5 | 1.80% |
| 2027 | 147.1 | 2.05% |
| 2028 | 158.6 | 2.22% |
| 2029 | 160.9 | 2.34% |
| 2030 | 163.8 | 2.42% |
| 2031 | 167.1 | 2.42% |
| 2032 | 170.8 | 2.42% |
| 2033 | 174.8 | 2.42% |
| 2034 | 179.1 | 2.42% |
Next, we calculate the terminal value using a conservative growth rate and a suitable discount rate. Assuming a terminal growth rate of 2.6% (the 5-year average of the 10-year government bond yield) and a cost of equity of 6.5% (based on Alarm.com's levered beta of 1.071), the terminal value can be estimated as follows:
Terminal Value (TV) = FCF2034 × (1 + g) / (r – g) = $179.1m × (1 + 2.6%) / (6.5% – 2.6%) = $5.0b
Now, we can sum the present value of the projected cash flows and the terminal value to estimate Alarm.com's fair value:
Fair Value = PVCF + PVTV = $1.1b + $2.7b = $3.8b
To determine the per-share fair value, we divide the total equity value by the number of outstanding shares. Assuming Alarm.com has 104.6 million shares outstanding:
Per-share Fair Value = $3.8b / 104.6 million shares ≈ $36.04
Comparing this estimate to Alarm.com's current stock price of $64.17, we can see that the company appears to be trading at a significant premium to its estimated fair value. However, it is essential to consider the potential risks and uncertainties associated with the DCF analysis and the assumptions made in the projections.
Alarm.com's growth prospects, competitive landscape, and regulatory environment all play a role in its future cash flows. As such, it is crucial for investors to stay informed about these factors and adapt their investment strategies accordingly. Additionally, alternative valuation methods, such as relative valuation or asset-based approaches, can provide a more comprehensive understanding of Alarm.com's fair value.
In conclusion, while the DCF analysis suggests that Alarm.com may be overvalued at its current stock price, investors should consider other factors and perform their own analysis before making investment decisions. By thoroughly evaluating a company's fundamentals, growth prospects, and risks, investors can make more informed decisions and potentially identify undervalued opportunities in the market.
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