In this article, we’ll estimate the intrinsic value of South Jersey Industries, Inc. (NYSE: SJI) by taking expected future cash flows and discounting them to today’s value. Our analysis will use the discounted cash flow (DCF) model. Don’t be put off by the lingo, the underlying calculations are actually pretty straightforward.
We draw your attention to the fact that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. If you still have burning questions about this type of valuation, take a look at the Simply Wall St.
Check out our latest review for South Jersey Industries
Crunch the numbers
As South Jersey Industries operates in the gas utility business, we have to calculate intrinsic value slightly differently. Instead of using free cash flow, which is difficult to estimate and often unreported by industry analysts, dividend payments per share (DPS) are used. This often underestimates the value of a stock, but it can still be a good comparison to the competition. The âGordon Growth Modelâ is used, which simply assumes that dividend payments will continue to increase at a sustainable growth rate forever. The dividend is expected to grow at an annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We then discount this figure to today’s value at a cost of equity of 5.5%. Compared to the current share price of US $ 24.6, the company appears slightly overvalued at the time of writing. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
Value per share = Expected dividend per share / (Discount rate – Perpetual growth rate)
= $ 1.3 / (5.5% – 2.0%)
= $ 19.8
We draw your attention to the fact that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 or the future capital needs of a company, so it does not give a full picture of a company’s potential performance. Since we consider South Jersey Industries 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 into account debt. . In this calculation, we have used 5.5%, 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 beta from the industry average beta from 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 piece of analysis you look at for a business. It is not possible to achieve a rock-solid valuation with a DCF model. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. What is the reason why the stock price exceeds intrinsic value? For South Jersey Industries, we’ve put together three important aspects that you should take a closer look at:
- Risks: Every company has them, and we have spotted 4 warning signs for South Jersey Industries (1 of which is of concern!) that you should know about.
- Future benefits: How does SJI’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
- 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. The Simply Wall St app performs a daily discounted cash flow assessment for every NYSE share. If you want to find the calculation for other actions, 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 any stock 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 any of the stocks mentioned.