In this article, we’ll estimate the intrinsic value of Sensient Technologies Corporation (NYSE: SXT) by taking the company’s future cash flow forecasts and discounting them to today’s value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don’t be put off by the lingo, the math is actually pretty straightforward.

Keep in mind, however, 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 the Simply Wall St.

Check out our latest review for Sensient Technologies

The calculation

We’re going to use a two-stage 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”. In the first step, 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 latest 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 discount the value of those future cash flows to their estimated value in today’s dollars. hui:

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 $ 1.3 billion

The next step is to calculate the Terminal Value, which takes into account all future cash flows after this ten-year period. 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 6.8%.

Terminal value (TV)= FCF₂₀₃₁ × (1 + g) ÷ (r – g) = US $ 242 million × (1 + 2.0%) ÷ (6.8% – 2.0%) = US $ 5.1 billion

Present value of terminal value (PVTV)= TV / (1 + r)^ten= US $ 5.1 billion ÷ (1 + 6.8%)^ten= 2.6 billion US dollars

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 $ 4.0 billion. In the last step, we divide the equity value by the number of shares outstanding. From the current share price of US $ 85.9, the company appears to be roughly at fair value at an 8.3% discount from the current share price. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.

Important assumptions

We draw your attention to the fact 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 view Sensient Technologies 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 6.8%, which is based on a leveraged beta of 1.028. 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.

To move on :

While important, calculating DCF shouldn’t be the only metric you look at when looking for a business. The DCF model is not a perfect equity valuation tool. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” 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. For Sensient Technologies, we have compiled three fundamental aspects that you should research further:

1. Risks: We think you should evaluate the 2 warning signs for Sensient Technologies we reported before making an investment in the business.
2. Future benefits: How does SXT’s growth rate compare to 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.
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.

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This Simply Wall St 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 material. Simply Wall St has no position in the mentioned stocks.
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