The time to buy shares is when they’re undervalued. But how do investors know when that is? The answer is with a discounted cash flow (DCF) analysis. And one tech stock stands out to me right now.
Discounted cash flow
A DCF calculation is a good way to value a business. It tells investors how much a stock is worth given certain assumptions. The calculation computes a value for a stock based on its future cash flows and a desired rate of return.
But that’s not all. Investors can also use the current share price and a rate of return to calculate implied future growth. And that’s what I’ve been doing.
Falling share prices imply lower growth forecasts. And this is what has been happening with software stocks recently. Investors are rethinking their future growth expectations, due to the threat of artificial intelligence (AI).
Lower sales and/or profit margins are a genuine possibility. But in some cases, current expectations have become very low.
Investing equation
Shares in Roper Technologies (NASDAQ:ROP) have fallen 41% from their highs. As a result, the enterprise value is $424 per share.
Management is forecasting adjusted earnings per share of $21.30 in 2026. And that’s a pretty good proxy for free cash flow.
A growth rate of 3% is usually reasonable for most companies. And a 9% target return is what I’m looking for from the stock. From here, a reverse DCF calculator can tell us the implied growth rate for the next five years. Here, it’s just over 6%.
Given that full-scale AI is still some way off, I think that’s highly achievable. That’s why I’ve been buying the stock. The falling share price has made a real difference. At its highs, the implied growth was much higher and the risk was much greater.
Valuations
At those highs, Roper had an enterprise value of $566 per share. And that makes the equation very different. At that level, a long-term growth rate of 3% implies 9% a year for the next five years. That’s possible, but it’s more demanding.
Acquisitions have been a big part of Roper’s growth in recent years. This has worked well, but it can be a risky strategy. The danger comes from overpaying for a business. And the firm has been paying higher multiples in recent years.
In the last few months however, the company has been seeing more value in its own stock. So it’s shifted to share buybacks. At the current multiples, this alone could get the firm most of the way to the 6% implied growth. That makes me optimistic.
Buying
A lot of software stocks are falling, but Roper looks very attractive to me. It offers investors something most other companies don’t.
The firm is a collection of businesses that specialise in different industries. That means it comes with two key advantages. One is diversification. Having operations across various different industries limits the impact of competition in any one.
The other is depth. Focused subsidiaries create more specialised products that are harder for competitors to disrupt.
Those two points are crucial. And with modest growth assumptions going forward, the stock is on my Buy list.
