Today I will be providing a simple run-through of the discounted cash flows (DCF) method to estimate the attractiveness of Vonage Holdings Corp (NYSE:VG) as an investment opportunity. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Also note that this article was written in March 2018 so be sure check the latest calculation for Vonage Holdings here.

Crunching the numbers

I use what is known as the 2-stage model, which takes into account the initial higher growth stage of a company’s life cycle and the steadier growth phase over the long run. To start off, I use the analyst consensus estimates of VG’s levered free cash flow (FCF) over the next five years and discounted these figures at the cost of equity of 8.49%. When estimates weren’t available, I’ve extrapolated the average annual growth rate over the previous five years, capped at a reasonable level. This resulted in a present value of 5-year cash flow of US$490.95M. Keen to know how I arrived at this number? Check out our detailed analysis here.

Above is a visual representation of how VG’s top and bottom lines are expected to move in the future, which should give you some color on VG’s outlook. Next, I determine the terminal value, which is the business’s cash flow after the first stage. I’ve decided to use the 10-year government bond rate of 2.8% as the perpetual growth rate, which is rightly below GDP growth, but more towards the conservative side. After discounting the terminal value back five years, the present value becomes US$1.55B.

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is US$2.04B. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value of $8.92, which, compared to the current share price of $10.38, we find that Vonage Holdings is fair value, maybe slightly overvalued at the time of writing.

Next Steps:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company.

For VG, I’ve compiled three essential aspects you should look at:

1. Financial Health: Does VG have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.

2. Future Earnings: How does VG’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: Are there other high quality stocks you could be holding instead of VG? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!