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Calculating The Fair Value Of JAKKS Pacific, Inc. (NASDAQ:JAKK)

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of JAKKS Pacific, Inc. (NASDAQ:JAKK) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!

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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for JAKKS Pacific

Is JAKKS Pacific Fairly Valued?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$20.0m

US$18.9m

US$18.3m

US$18.0m

US$17.9m

US$17.9m

US$18.0m

US$18.2m

US$18.5m

US$18.7m

Growth Rate Estimate Source

Analyst x1

Est @ -5.46%

Est @ -3.24%

Est @ -1.69%

Est @ -0.6%

Est @ 0.16%

Est @ 0.7%

Est @ 1.07%

Est @ 1.33%

Est @ 1.51%

Present Value ($, Millions) Discounted @ 7.7%

US$18.6

US$16.3

US$14.6

US$13.4

US$12.3

US$11.5

US$10.7

US$10.1

US$9.5

US$8.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$125m

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. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (1.9%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.7%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$19m× (1 + 1.9%) ÷ (7.7%– 1.9%) = US$332m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$332m÷ ( 1 + 7.7%)10= US$158m

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$283m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$24.1, the company appears about fair value at a 18% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

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. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 JAKKS Pacific 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 7.7%, which is based on a levered beta of 1.358. 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.

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or 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. For JAKKS Pacific, there are three additional factors you should further examine:

  1. Risks: For example, we've discovered 3 warning signs for JAKKS Pacific (1 is concerning!) that you should be aware of before investing here.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for JAKK's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

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

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