Today we are going to review a valuation method used to estimate the attractiveness of VF Corporation (NYSE: VFC) as an investment opportunity by taking expected future cash flows and discounting them to their. current value. One way to do this is to use 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 want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St.

Crunch the numbers

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. 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 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 $ 12 billion

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 7.1%.

Terminal value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = US $ 2.5B × (1 + 2.0%) ÷ (7.1% – 2.0%) = US $ 49B

Present value of terminal value (PVTV)= TV / (1 + r)^ten= US $ 49 billion ÷ (1 + 7.1%)^ten= US $ 25 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 $ 37 billion. In the last step, we divide the equity value by the number of shares outstanding. From the current price of US $ 70.8, the company appears to be slightly undervalued at a 25% discount from the current share price. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.

NYSE: VFC Discounted Cash Flow October 28, 2021

The hypotheses

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 complete picture of a company’s potential performance. Since we consider VF 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 7.1%, which is based on a leveraged beta of 1.170. 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.

Looking forward:

While important, calculating DCF ideally won’t be the only piece of analysis you’ll look at for a business. The DCF model is not a perfect equity valuation tool. 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, changes in the company’s cost of equity or the risk-free rate can have a significant impact on valuation. Why is intrinsic value greater than the current share price? For VF, there are three essentials you should research further:

1. Risks: To do this, you need to know the 1 warning sign we spotted with VF.
2. Future benefits: How does VFC’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.
3. Other strong companies: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you might not have considered!

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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