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I am going to run you through how I calculated the intrinsic value of GameStop Corp. (NYSE:GME) by taking the foreast future cash flows of the company and discounting them back to today’s value. I will use the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. Please also note that this article was written in January 2019 so be sure check out the updated calculation by following the link below.

View our latest analysis for GameStop

What’s the value?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second ‘steady growth’ period. To begin with we have to get estimates of the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow estimate

Present Value of 5-year Cash Flow (PVCF)= US$918m

We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.9%. We discount this to today’s value at a cost of equity of 12.5%.

Terminal Value (TV) = FCF₂₀₂₃ × (1 + g) ÷ (r – g) = US$272m × (1 + 2.9%) ÷ (12.5% – 2.9%) = US$2.9b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = US$2.9b ÷ ( 1 + 12.5%)⁵ = US$1.6b

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$2.5b. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of $24.98. Relative to the current share price of $15.24, the stock is quite undervalued at a 39% discount to what it is available for right now.

The assumptions

I’d like to point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at GameStop as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 12.5%, which is based on a levered beta of 1.353. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.