How far is Schweitzer-Mauduit International, Inc. (NYSE: SWM) from its intrinsic value? Using the most recent financial data, we’ll examine whether the stock’s price is fair by taking expected 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.

There are many ways that businesses can be valued, so we would like to stress that a DCF is not perfect for all situations. For those who are learning equity analysis in depth, the Simply Wall St analysis template here may be of interest to you.

See our latest analysis for Schweitzer-Mauduit International

The model

We use what is called a 2-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 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 the last published value. We assume that companies with decreasing free cash flow will slow their withdrawal rate, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect that growth tends to slow down more in the early years than in the later years.

Typically, 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) forecast

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flow (PVCF) = $ 757 million

Now we need to calculate the terminal value, which takes into account all future cash flows after that 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 present value, using a cost of equity of 11%.

Terminal value (TV)= FCF₂₀₃₀ × (1 + g) ÷ (r – g) = US $ 152 million × (1 + 2.0%) ÷ (11% – 2.0%) = US $ 1.7 billion

Present value of terminal value (PVTV)= TV / (1 + r)^ten= $ 1.7 billion ÷ (1 + 11%)^ten= 584 million USD

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is US $ 1.3 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 $ 40.9, the company appears to have fair value at a 4.2% 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.

The hypotheses

The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. You don’t have to agree with these entries, I recommend that you redo the math yourself and play around with it. 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 Schweitzer-Mauduit International 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 11%, which is based on a leveraged beta of 1.947. 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 of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Looking forward:

While important, the DCF calculation is just one of the many factors you need to assess for a business. The DCF model is not a perfect inventory valuation tool. Preferably, you would apply different cases and assumptions and see how they would impact 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 Schweitzer-Mauduit International, we have compiled three relevant factors that you should consider in more detail:

1. Risks: For example, we discovered 1 warning sign for Schweitzer-Mauduit International which you should be aware of before investing here.
2. Future income: How does SWM’s growth rate compare to its peers and to the market in general? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth forecast chart.
3. Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high quality inventory 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. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals or your financial situation. We aim 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 information. Simply Wall St has no position in any of the stocks mentioned.
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