Does the July share price for Woodward, Inc. (NASDAQ: WWD) reflect what it is really worth? Today, we’re going to estimate the intrinsic value of the stock by projecting its future cash flows, then discounting them to today’s value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too hard to follow, as you will see in our example!
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 would like to know more about discounted cash flows, the rationale for this calculation can be read in detail in the Simply Wall St analysis model.
See our latest analysis for Woodward
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 a lower growth stage. To begin with, we need to get cash flow estimates for 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 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.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we discount the value of those future cash flows to their estimated value in today’s dollars. hui:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF ($, Millions)||US $ 356.5 million||US $ 374.7 million||US $ 367.6 million||US $ 364.9 million||365.2 million US dollars||US $ 367.6 million||US $ 371.5 million||US $ 376.5 million||US $ 382.3 million||US $ 388.6 million|
|Source of estimated growth rate||Analyst x5||Analyst x3||Est @ -1.89%||East @ -0.73%||Is @ 0.09%||Is @ 0.66%||East @ 1.06%||Est @ 1.34%||Is @ 1.53%||East @ 1.67%|
|Present value (in millions of dollars) discounted at 7.2%||US $ 333||US $ 326||US $ 299||US $ 277||US $ 258||US $ 243||US $ 229||$ 216||205 USD||$ 194|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 2.6 billion US dollars
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 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 “growth” period, we discount future cash flows to their present value, using a cost of equity of 7.2%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US $ 389 million × (1 + 2.0%) ÷ (7.2% to 2.0%) = US $ 7.6 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= 7.6 billion US dollars (1 + 7.2%)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 $ 6.4 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 $ 119, the company appears to be around fair value at the time of writing. 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.
The above calculation is very dependent on two assumptions. One is the discount rate and the other is 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 view Woodward as a potential shareholder, 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 7.2%, which is based on a leveraged beta of 1.099. 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 a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.
While a business valuation is important, ideally, it won’t be the only analysis you look at for a business. It is not possible to achieve a rock-solid valuation with a DCF model. 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, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For Woodward, we’ve compiled three more aspects you should explore:
- Financial health: Does WWD have a healthy track record? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future benefits: How does WWD’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 valuation for each NASDAQGS 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. 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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