Today we will discuss one way to estimate the intrinsic value of Ford Motor Company (NYSE:F) by taking the expected future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. This may sound complicated, but it’s actually quite simple!
We will note that there are many ways to assess a company and, like DCF, each technique has advantages and disadvantages in certain scenarios. For those who study equity analysis, the Simply Wall St analysis model here may be of interest to you.
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We use a 2-stage growth model, which means we take into account two stages of a company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we have to get a cash flow forecast for the next ten years. Where possible, we use analyst forecasts, but if these are not available, we estimate previous free cash flows (FCFs) from the most recent forecast or reported values. We assume that firms with shrinking free cash flow will slow their depreciation rate, and that firms with growing free cash flow will see their growth rate slow, during this period. We do this to reflect that growth tends to be slower in the early years than in later years.
We generally assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today’s dollars:
Estimated free cash flow (FCF) 10 years
|FCF Levers ($, Millions)||US$4.24b||US$5.68b||US$6.27 billion||US$7.66 billion||$8.69b||US$9.55b||US$10.3 billion||US$10.9b||US$11.4b||US$11.8b|
|Source of Estimated Growth Rate||Analyst x5||Analyst x5||Analyst x2||Analyst x2||Estimate @ 13.35%||Estimate @ 9.93%||Estimated @ 7.53%||Estimated @ 5.85%||Estimate @ 4.68%||Estimated @ 3.86%|
|Present Value ($, Millions) Discount @ 10%||US$3.8k||US$4.7k||US$4.7k||US$5.2k||US$5.3k||US$5.3k||$5.1k||US$4.9k||US$4.7k||US$4.4k|
(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flows (PVCF) = US$48 billion
We now need to calculate Terminal Value, which takes into account all future cash flows after this ten year period. For a number of reasons, a very conservative growth rate is used which cannot exceed the GDP growth of a country. In this case we have used the 5-year average of the 10-year government bond yields (1.9%) to forecast future growth. In the same way as for a 10-year ‘growth’ period, we discount future cash flows to today’s values, using a 10% cost of equity.
Terminal Value (TV)= FCF2032 × (1 + g) (r – g) = US$12 billion× (1 + 1.9%) (10%– 1.9%) = US$142 billion
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$142b÷ ( 1 + 10%)10= US$53 billion
The total value is the sum of the cash flows for the next ten years plus the discounted terminal value, resulting in Total Value of Equity, which in this case is US$101 billion. In the last step we divide the value of equity by the number of shares outstanding. Compared to the current share price of US$15.2, the value of the company looks quite good with a 39% discount from the share price currently traded. Assumptions in any calculation have a huge impact on valuation, so it’s better to see this as a rough estimate, not precise to the last penny.
We will show that the most important inputs for discounted cash flows are the discount rate and of course actual cash flows. You don’t have to agree with this input, I recommend repeating the calculations yourself and playing with it. DCF also does not consider the possibility of industry cycles, or the company’s future capital requirements, so it does not provide a complete picture of the company’s potential performance. Given that we view Ford Motor as a potential shareholder, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we have used 10%, which is based on a beta leverage of 2,000. Beta is a measure of a stock’s volatility, compared to the market as a whole. We derive our betas from the industry average betas of globally comparable companies, with limits imposed between 0.8 and 2.0, which is a reasonable range for a stable business.
Valuation is only one side of the coin when it comes to building your investment thesis, and it is only one of the many factors you need to assess for a company. The DCF model is not the all and end of all investment appraisal. Rather it should be seen as a guide to “what assumptions must be true for this stock to be under/overvalued?” If a firm grows at different rates, or if its cost of equity or risk-free rate changes sharply, its output can look very different. What is the reason stock prices are below intrinsic value? For Ford Motor, we’ve rounded up three further items that you should pay attention to:
- Risk: Every company has it, and we have seen it 2 warning signs for Ford Motor (one of which doesn’t match ours!) that you should know.
- Future income: How does F’s growth rate compare to its peers and the wider market? Dig deeper into analyst consensus figures for the coming years by interacting with our free analyst growth expectations chart.
- Other High Quality Alternatives: Do you like a good all-rounder? Browse our interactive list of high quality stock to get an idea of what else is out there that you might have missed!
PS. Simply Wall St updates DCF calculations for each American stock daily, so if you want to find the intrinsic value of other stocks, simply search here.
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This article from Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts using only an unbiased methodology and our article is not intended as financial advice. This 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 provide you with long-term focused analysis driven by fundamental data. Note that our analysis may not account for price-sensitive company announcements or recent qualitative material. Simply Wall St has no positions in any of the stocks mentioned.
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