How far is Dover Corporation (NYSE:DOV) from its intrinsic value? Using the most recent financial data, we will examine whether the stock price is fair by taking the company’s projected future cash flows and discounting them to the present value. One way to do this is to use the discounted cash flow (DCF) model. There really isn’t much to do, although it may seem quite complex.
We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.
Check out our latest analysis for Dover
Step by step in the calculation
We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. To begin with, we need to obtain cash flow estimates for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.
Generally, we assume that a dollar today is worth more than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today’s dollars:
Estimated free cash flow (FCF) over 10 years
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leveraged FCF ($, millions) | $1.19 billion | $1.30 billion | $1.47 billion | $1.60 billion | $1.70 billion | $1.77 billion | $1.84 billion | $1.90 billion | $1.95 billion | US$2,000,000,000 |
Growth rate estimate Source | Analyst x9 | Analyst x9 | Analyst x3 | Analyst x2 | Analyst x1 | Is at 4.48% | Is at 3.71% | Is at 3.18% | East @ 2.8% | Is at 2.54% |
Present value (in millions of dollars) discounted at 6.5% | $1,100 | $1,100 | $1,200 | $1,200 | $1,200 | $1,200 | $1,200 | $1,100 | $1,100 | $1,100 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $12 billion
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 stage. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.9%. We discount terminal cash flows to present value at a cost of equity of 6.5%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = $2.0 billion × (1 + 1.9%) ÷ (6.5%–1.9%) = $45 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= $45 billion ÷ (1 + 6.5%)^{ten}= $24 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $36 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of US$143, the company appears to be pretty good value at a 42% discount to the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in a different galaxy. Keep that in mind.
Important assumptions
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we view Dover as 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 factors in debt. In this calculation, we used 6.5%, which is based on a leveraged beta of 1.071. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Let’s move on :
Valuation is only one side of the coin in terms of crafting your investment thesis, and it shouldn’t be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. If a company grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output may be very different. Can we understand why the company is trading at a discount to its intrinsic value? For Dover, we’ve compiled three important factors you should consider:
- Risks: Every business has them, and we’ve spotted 3 warning signs for Dover you should know.
- Management: Did insiders increase their shares to take advantage of market sentiment about DOV’s future prospects? View our management and board analysis with insights into CEO compensation and governance factors.
- Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!
PS. The Simply Wall St app performs a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks, search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.