In this article, we’ll estimate the intrinsic value of Portland General Electric Company (NYSE: POR) by taking the company’s future cash flow forecasts and discounting them to today’s value. To this end, we will take advantage of the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too hard to follow, as you will see in our example!
There are many ways that businesses can be assessed, so we would like to point out that a DCF is not perfect for all situations. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.
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Crunch the numbers
We use what is called a two-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. To begin with, we need to estimate the next ten years of cash flow. 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 stated 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 down more in the early years than in subsequent years.
In general, 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:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF ($, Millions)||US $ 64.0 million||US $ 107.0 million||US $ 137.0 million||US $ 165.0 million||US $ 185.7 million||203.1 million US dollars||US $ 217.7 million||US $ 229.9 million||US $ 240.3 million||US $ 249.3 million|
|Source of estimated growth rate||Analyst x1||Analyst x1||Analyst x1||Analyst x1||Est @ 12.55%||Est @ 9.38%||Est @ 7.16%||Est @ 5.61%||Is 4.52%||East @ 3.76%|
|Present value (in millions of dollars) discounted at 5.8%||US $ 60.5||US $ 95.7||116 USD||132 USD||140 USD||145 USD||$ 147||$ 147||145 USD||$ 142|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 1.3 billion
It is now a matter of calculating the Terminal Value, which takes into account all future cash flows after this ten-year period. For a number of reasons, a very conservative growth rate is used which 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 “growth” period, we discount future cash flows to their present value, using a cost of equity of 5.8%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US $ 249 million × (1 + 2.0%) ÷ (5.8% – 2.0%) = US $ 6.7 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= US $ 6.7 billion ÷ (1 + 5.8%)ten= 3.8 billion US dollars
The total value is the sum of the cash flows for the next ten years plus the final present value, which gives the total value of equity, which in this case is US $ 5.1 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. From the current share price of US $ 51.7, the company appears to be roughly at fair value with a 9.7% discount to the current share price. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. If you don’t agree with these results, try the calculation yourself and play with the assumptions. 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 Portland General Electric 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 takes into account debt. . In this calculation, we used 5.8%, which is based on a leverage beta of 0.800. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our average beta from the industry beta of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
To move on :
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a business. DCF models are not the ultimate solution for investment valuation. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. For Portland General Electric, you need to assess three essential aspects:
- Risks: Consider, for example, the ever-present specter of investment risk. We have identified 3 warning signs with Portland General Electric (at least 1 which makes us a little uncomfortable), and understanding them should be part of your investment process.
- Management: Have insiders increased their stocks to take advantage of market sentiment about POR’s future prospects? Check out our management and board analysis with information on CEO compensation and governance factors.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what 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 just 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 using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is 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 documents. Simply Wall St has no position in the mentioned stocks.
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