Calculation of fair value of Danaher Corporation (NYSE: DHR)
Does the December share price for Danaher Corporation (NYSE: DHR) reflect its true value? Today we’re going to estimate the intrinsic value of the stock by taking the company’s future cash flow forecast and discounting it 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 generally think of a business’s value as the present value of all the cash it will generate in the future. However, a DCF is only one evaluation measure among many, and it is not without its flaws. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something of interest to you.
Crunch the numbers
We use the 2-step growth model, which simply means that we take into account two stages of business growth. During the initial period, the business can have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. 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 need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year free cash flow (FCF) forecast
2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | |
Leverage FCF ($, Millions) | 7.32 billion US dollars | 7.68 billion US dollars | 9.19 billion US dollars | 8.86 billion US dollars | US $ 8.70 billion | 8.64 billion US dollars | 8.65 billion US dollars | 8.71 billion US dollars | 8.80 billion US dollars | 8.91 billion US dollars |
Source of estimated growth rate | Analyst x6 | Analyst x6 | Analyst x2 | Analyst x1 | Is @ -1.81% | East @ -0.68% | Is 0.11% | East @ 0.67% | Is @ 1.05% | Est @ 1.33% |
Present value (in millions of dollars) discounted at 6.0% | US $ 6.9,000 | US $ 6.8k | $ 7.7,000 | US $ 7,000 | US $ 6.5,000 | US $ 6.1k | $ 5.8,000 | 5.5,000 USD | US $ 5.2k | $ 5.0,000 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 62 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 step. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We discount the terminal cash flows to their present value at a cost of equity of 6.0%.
Terminal value (TV)= FCF_{2031} × (1 + g) ÷ (r – g) = US $ 8.9B × (1 + 2.0%) ÷ (6.0% – 2.0%) = US $ 225B
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= US $ 225 billion ÷ (1 + 6.0%)^{ten}= 126 billion US dollars
Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is US $ 188 billion. The last step is then to divide the equity value by the number of shares outstanding. Compared to the current share price of US $ 313, the company appears to be around fair value at the time of writing. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
NYSE: DHR Discounted Cash Flow December 4, 2021
The hypotheses
The above calculation is very dependent on two assumptions. One is the discount rate and the other is the 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 full picture of a company’s potential performance. Since we view Danaher 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 debt into account. In this calculation, we used 6.0%, which is based on a leveraged beta of 0.921. 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.
Next steps:
While important, calculating DCF shouldn’t be the only metric you look at when looking for 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 Danaher, we’ve compiled three relevant things you should explore:
- Risks: As an example, we have found 2 warning signs for Danaher that you need to consider before investing here.
- Future benefits: How does DHR’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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