Dover Corporation (NYSE: DOV) shares could be 24% lower than their estimate of intrinsic value
Does Dover Corporation’s (NYSE: DOV) October Share Price Reflect Its True Value? Today, we’re going to estimate the intrinsic value of the stock by estimating the company’s future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won’t be able to figure it out, read on! It’s actually a lot less complex than you might imagine.
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 flow, the rationale for this calculation can be read in detail in the Simply Wall St.
See our latest review for Dover
Step by step in the calculation
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.
In general, we assume that a dollar today is worth more than a dollar in the future, 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) estimate
|Leverage FCF ($, Millions)||US $ 1.09 billion||US $ 1.21 billion||US $ 1.27 billion||US $ 1.41 billion||US $ 1.50 billion||US $ 1.58 billion||US $ 1.64 billion||US $ 1.70 billion||US $ 1.75 billion||US $ 1.80 billion|
|Source of growth rate estimate||Analyst x8||Analyst x4||Analyst x2||Analyst x1||Est @ 6.37%||East @ 5.05%||Est @ 4.12%||East @ 3.47%||East @ 3.02%||Is 2.7%|
|Present value (in millions of dollars) discounted at 6.8%||US $ 1.0k||US $ 1.1k||US $ 1.0k||US $ 1.1k||US $ 1.1k||US $ 1.1k||US $ 1.0k||US $ 1.0k||US $ 965||US $ 927|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 10 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. 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 6.8%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US $ 1.8B × (1 + 2.0%) ÷ (6.8% – 2.0%) = US $ 38B
Present value of terminal value (PVTV)= TV / (1 + r)ten= US $ 38 billion ÷ (1 + 6.8%)ten= US $ 19 billion
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 $ 30 billion. In the last step, we divide the equity value by the number of shares outstanding. From the current share price of $ 156, the company appears to be slightly undervalued at a 24% discount from the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
We would like to stress 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 Dover 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 debt into account. In this calculation, we used 6.8%, which is based on a leveraged beta of 1.116. 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.
While important, calculating DCF shouldn’t be the only metric you look at when looking 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. 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 is below intrinsic value? For Dover, there are three additional aspects you should explore:
- Risks: Take risks, for example – Dover a 1 warning sign we think you should be aware.
- Future benefits: How does DOV’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus count 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.
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 any of the stocks mentioned.
Do you have any feedback on this item? Are you worried about the content? Get in touch with us directly. You can also send an email to the editorial team (at) simplywallst.com.
If you decide to trade on Dover, use the cheapest platform * which is ranked # 1 overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, currencies, bonds and funds in 135 markets, all from one integrated account.Promoted