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Methodology: To forecast the future by projecting the past into the future.

Personally, to find the true value of industrial stock (as opposed to financial or insurance value), the primary focus is on the free cash flow that can be defined as operating cash flow minus capital expenditures. Generally, this free cash flow is what remains after deducting what is strictly needed for survival from all the cash produced by a company in one year. From the point of view of an investor, this free cash flow is what really matters, as it's the real added value that may be entirely distributed to the stakeholders without compromising a company's existence.

By projecting the free cash flow to the future and discounting it back (employing the so-called weighted average cost of capital, after having performed some other technical steps), it's possible to reach the fair value of stock compared with its market price. However, the big issue is to choose an appropriate free cash flow future growth rate. This task can be accomplished by looking back into the financial reports of the target company to see how it performed in the past.

Based on this methodology, Adobe (NASDAQ:ADBE) is now overvalued: The operating cash flow for the last 12 months stands at $1.5bn and capital expenditures totaling $271m, so the free cash flow is $1.229bn with the weighted average cost of capital computed at 10.3%. Using data from the most recent 10-K form, the estimated impact of operating leases and outstanding stock options combined is $546m. A reasonable free cash flow growth rate for the short/medium term (up to 10 years) could be estimated at 0.8%, considering the last 5-year operating cash flow at a Compound Annual Growth Rate.

While in the long term (over ten years), this rate is estimated at a stable 2.75% which is equal to growth rate projections for the overall world economy. Given all the above-mentioned assumptions, the final calculation gives a value per ordinary share equal to $32.11, which is about 15.8% lower than the closing price of $38.14 on the 8 Jan 2013

Free cash flow trailing twelve m. ($ million)


Discount rate (weighted average c. of c.)


Cash flow growth rate


Perpetuity growth


Present Value of Free cash flows ($ million)


Present Value of Terminal Value ($ million)


Value of operating assets ($ million)


Total value of Cash & Marketable Securities ($ million)


Value of Firm ($ million)


Total value of outstanding debt ($ million)


Operating leases/Value of Equity in Options ($ million)


Total Value of Equity ($ million)


Total outstanding shares (million)


Estimated Fair Value of one ordinary share

$ 32.11

Source: Adobe: No Room For More Upside Potential