To The Moon

How do you make your decisions when you decide to invest in a certain company? Today let's introduce the concept of fair value. Fair value is the sale price agreed upon by a willing buyer and seller. The fair value of a stock is determined by the market where the stock is traded. Fair value also represents the value of a company’s assets and liabilities when a subsidiary company’s financial statements are consolidated with a parent company.

For example, if the investor has calculated that the fair value per share of XYZ company is $100, while shares of the company is currently trading at $85 per share, the investor will consider the stock of XYZ to be under valued by 15% and buy the stock. If the share is trading at $115, that would mean the stock is over valued by 15% and the investor decides that hewould be over paying if he buys the stock right now, and would instead wait for a correction in the price before making further decisions on this investment.

However it is important to note that the fair value and the current price or how the stock price moves in the short term is not guaranteed, as the market is an emotional machine thatis easily swayed by news, etc. But as long as the company is able to deliver targets and continue to grow, the stock will trend towards the fair value eventually.

MSFT fair value of $335 assuming WACC 7.35% and Terminal Growth Rate of 3%

In the example above, I have use Microsoft, and assumed a 5 year Discounted Cash Flow model, by assuming it's revenue growth and operating margin % in the next 5 years. After subtracing taxes, adding depreciation & ammortisation (D&A), subtracting capital expenditure (CapEx) and subtracting change in non working captital, one will get the FCF for the year. Following that,you would need to obtain the present value (PV), where:

PV = Future Value / (1 + rate of return)^n, where n = time period, e.g. year 1, year 2, etc.

The terminal value of the 5th year is calculated by:

TV = Unlevered FCF of 5th year * (1 + Terminal Growth Rate) / (Weighted Average Cost of Capital - Terminal Growth Rate)

Summing up the 5 year's FCF and the TV at end of year 5, you obtain the enterprise value, and then you would need cash minus debt to obtain the equity value. Divided by the number of outstanding shares, you finally arrive at the fair value.

The model depends on estimates on revenue growth, margin %, how much D&A and CapEx and change in non working captial, and of course you would need some guidance by looking up the finance websites like Morningstar, Seeking Alpha, Gurufocus, etc.

In my model, I have found Microsoft to have potential 39% upside.

TSLA is over valued

However, when I applied the model to Tesla, by nature of being in the automotive industry and considered relatively in the early growth stage, I needed to assume a higher capex and give reasonable revenue growth to it. That would mean Tesla is over priced by 45.9%, which has been quite true if you look at other means of valuing it like using PE ratio, Price to Sales ratio etc.

Using forward Price Multiple estimate of 17x with 25% future growth in 5 years, TSLA still has upside

However, if I use a PE multiple method of valuing it, and assuming a growth rate of 22.5% to 27.5% and a forward 5 year PE with low, base and high case of 15x, 17x and 19x respectively, I have worked out a range of fair values for Tesla. In my base case scenario, there is still a 45% upside potential from today's prices.

How do you make your decisions before investing in a certain stock? Do you consider it's fair value, etc. Share it in the comments section.

**Disclaimer: The estimates/fair values are purely for research and educational purposes, where the numbers will change depending on the assumptions in your model, please do your own due diligence before making your investment.**

$Microsoft(MSFT)$  

$Tesla Motors(TSLA)$  

@TigerStars