In this article, we’ll estimate the intrinsic value of Carriage Services, Inc. (NYSE: CSV) by estimating the company’s future cash flows and discounting them to their present value. To this end, we will take advantage of the Discounted Cash Flow (DCF) model. It may sound complicated, but it’s actually quite simple!

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 want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St.

What is the estimated valuation?

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. First, we need to estimate the cash flow of the business over 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) estimate

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 526 million

The second stage is also known as terminal value, this is the cash flow of the business after the first stage. 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 6.6%.

Terminal value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = US $ 81 million × (1 + 2.0%) ÷ (6.6% – 2.0%) = US $ 1.8 billion

Present value of terminal value (PVTV)= TV / (1 + r)^ten= US $ 1.8 billion ÷ (1 + 6.6%)^ten= US $ 949 million

Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is US $ 1.5 billion. The last step is then to divide the equity value by the number of shares outstanding. From the current share price of US $ 51.7, the company looks fairly good value at a 42% discount from where the stock price is currently trading. 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.

NYSE: CSV Discounted Cash Flow November 19, 2021

Important assumptions

The above calculation is very dependent on two assumptions. One is the discount rate and the other is the cash flow. 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 view Carriage Services 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 6.6%, which is based on a leveraged beta of 1.053. 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 comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

To move on :

While valuing a business is important, it’s just one of the many factors you need to assess for a business. DCF models are not the ultimate solution for investment valuation. 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. What is the reason why the stock price is below intrinsic value? For transportation services, you need to explore three essential factors:

1. Risks: Consider, for example, the ever-present specter of investment risk. We have identified 3 warning signs with transport services (at least 1 which is not too good for us), and understanding them should be part of your investment process.
2. Management: Have insiders increased their stocks to take advantage of market sentiment about CSV’s future prospects? Check out our management and board analysis with information on CEO compensation and governance factors.
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. Simply Wall St updates its DCF calculation for every US stock every day, so if you want to find the intrinsic value of any other stock 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 the mentioned stocks.

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