How far is Dover Corporation (NYSE: DOV) from its intrinsic value? Using the most recent financial data, we’ll examine whether the share price is fair by estimating the company’s future cash flows and discounting them to their present value. To this end, we will take advantage of the Discounted Cash Flow (DCF) model. Before you think you won’t be able to figure it out, read on! It’s actually a lot less complex than you might imagine.
Businesses can be valued in many ways, so we would like to stress that a DCF is not perfect for all situations. If you want to know more about discounted cash flows, the rationale for this calculation can be read in detail in the Simply Wall St analysis model.
We use what is called a 2-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. First, we need to estimate the cash flow of the business over the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or the last reported value. We assume that companies with decreasing free cash flow will slow their withdrawal rate, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect that growth tends to slow down more in the early years than in the later years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and therefore the sum of these future cash flows is then discounted to present value:
10-year Free Cash Flow (FCF) forecast
|Levered FCF ($, million)||$ 939.1 million||$ 1.03 billion||$ 1.10 billion||$ 1.23 billion||$ 1.32 billion||$ 1.38 billion||$ 1.44 billion||$ 1.49 billion||1.54 billion USD||1.58 billion USD|
|Source of estimated growth rate||Analyst x8||Analyst x8||Analyst x4||Analyst x1||Analyst x1||Is 5.04%||Is 4.12%||Is 3.48%||Is 3.04%||Is 2.72%|
|Present value ($, million) discounted at 7.3%||$ 875||US $ 893||US $ 889||US $ 928||US $ 926||US $ 907||US $ 880||$ 849||US $ 816||US $ 781|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = 8.7 billion USD
After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. 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 used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. Similar to the 10-year âgrowthâ period, we discount future cash flows to present value, using a cost of equity of 7.3%.
Terminal value (TV)= FCF2030 Ã (1 + g) Ã· (r – g) = $ 1.6 billion Ã (1 + 2.0%) Ã· (7.3% – 2.0%) = $ 30 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= $ 30 billion Ã· (1 + 7.3%)ten= 15 billion USD
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is US $ 24 billion. In the last step, we divide the equity value by the number of shares outstanding. From the current share price of US $ 151, the company appears to have fair value at a discount of 8.9% from the current share price. Remember though, this is only a rough estimate, and like any complex formula – garbage in, garbage out.
NYSE: DOV Discounted Cash Flow May 30, 2021
Now the most important data for a discounted cash flow is the discount rate and, of course, the actual cash flow. You don’t have to agree with these entries, I recommend that you redo the math yourself and play around with it. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Dover to be 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 takes debt into account. In this calculation, we used 7.3%, which is based on a leveraged beta of 1.121. Beta is a measure of the volatility of a stock, relative 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.
Valuation is only one side of the coin in terms of building your investment thesis, and ideally it won’t be the only analysis you look at for a business. DCF models are not the alpha and omega of investment valuation. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. For Dover, we’ve compiled three relevant things you should consider:
- Risks: For example, we discovered 2 warning signs for Dover which you should be aware of before investing here.
- Management: Have insiders increased their shares to take advantage of market sentiment for DOV’s future outlook? Discover our board management and analysis with information on CEO compensation and governance factors.
- Other high quality alternatives: Do you like a good all-rounder? To explore our interactive list of high quality stocks to get an idea of ââwhat you might be missing!
PS. Simply Wall St updates its DCF calculation for every US stock every day, so if you want to find the intrinsic value of any other stock simply search here.
This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals or your financial situation. We aim to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative information. Simply Wall St has no position in the mentioned stocks.
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