Ford Motor Company (NYSE: F) has garnered interest lately. After the successful launch of the all-electric F-150 truck, the company posted surprising profits in the second quarter.

Yet the company remains at a modest valuation. While reasonable by historical standards, the P / E valuation of 16 can be considered low for now. We will estimate the intrinsic value of the stock using a Discounted Cash Flow (DCF) model.

Second quarter earnings surprise

Q2 earnings per share surprised with US $ 0.13 versus US $ 0.04 estimated negative. Auto revenue of US $ 24.12 climbed 45.1% year-on-year and topped estimates by US $ 1.29 billion.

The company raised its 2021 EBIT guidance by 50% to a profit of US $ 9 billion. They expect the chip shortage to ease in the second half of the year.

Ford also has a stake in Rivian and Argo, which are expected to go public within a year. With their valuations in the tens of billions, successful IPOs can provide significant favorable winds for the stock.

Electric vehicle orders pile up

Bookings of F-150 Lightning trucks now exceed 120,000, while Ford Maverick, a $ 20,000 compact hybrid pickup, has 80,000 orders. Obviously, the company relies on strong brand loyalty to retain customers, but also takes advantage of the scale of production to keep the price attractive.

Currently, sales of electric vehicles are based on only 3 models: Mach-E SUV, F-150 Hybrid and Escape Plug-in Hybrid. However, as the F-150 Lightning goes on sale in 2022, this will mark a potential pivot to the new all-electric lineup.

Find the value

Remember that there are many ways to estimate the value of a business, and a DCF is just one method.If you still have burning questions about this type of valuation, take a look at Simply Wall St.

Check out our latest review for Ford Motor

Step by step in the calculation

We will be using a two-step DCF model, which, as the name suggests, takes into account two growth stages. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of steady growth. To begin with, we need to estimate the next ten years of cash flow. 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 all about the idea that a dollar in the future is worth less than a dollar today, we therefore discount the value of these future cash flows to their estimated value in today’s dollars:

10-year free cash flow (FCF) forecast

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 52 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 several 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 11%.

Terminal value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = US $ 11 billion × (1 + 2.0%) ÷ (11% – 2.0%) = US $ 120 billion

Present value of terminal value (PVTV)= TV / (1 + r)^ten= US $ 120 billion ÷ (1 + 11%)^ten= US $ 41 billion

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is US $ 93 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 $ 13.9, the company seems quite good value for money with a 40% discount from the current share price. The assumptions in any calculation have a significant impact on the valuation, so it’s best to think of this as a rough estimate, not precise down to the last penny.

Important assumptions

The above calculation is very dependent on two assumptions. One is the discount rate, and the other is the cash flow. You do not have to agree to these entries. I recommend doing the math yourself and playing around with them. The DCF also does not take into account the possible cyclicality of an industry or its future capital needs, so it does not fully reflect a company’s potential performance.

Since we view Ford Motor as potential shareholders, the cost of equity is used as the discount rate rather than the cost of capital (or the weighted average cost of capital, WACC), which takes into account debt. In this calculation, we used 11% based on a leveraged beta of 2,000. 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.

Looking forward:

Although important, the calculation of the 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. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. What is the reason why the stock price is below intrinsic value? For Ford Motor, we have compiled three fundamental aspects you should continue your research:

1. Risks: Take risks; for example – Ford Motor has 1 warning sign we think you should be aware.
2. Future benefits: How does F’s growth rate compare to that of its peers and the market in general? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth expectations chart.
3. 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 stocks, search here.

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Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no positions in any of the companies mentioned. This 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.
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