Worthington Industries, Inc. (NYSE:WOR) is a company that can potentially be undervalued based on the two-stage Discounted Cash Flow (DCF) model. By taking the forecast future cash flows of the company and discounting them back to today’s value, we can estimate its intrinsic value. In this article, we will explain the steps involved in this calculation and discuss the assumptions made.
The first step in the DCF model is to estimate the next ten years of cash flows. Analyst estimates are used where available, but when not available, the previous free cash flow (FCF) is extrapolated. The growth rate of the FCF is adjusted to reflect the fact that growth tends to slow more in the early years than in later years. These cash flows are then discounted to today’s value, assuming that a dollar today is more valuable than a dollar in the future.
After calculating the present value of future cash flows in the initial ten-year period, the Terminal Value is calculated. This accounts for all future cash flows beyond 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. The terminal cash flows are then discounted to today’s value using the cost of equity.
The Total Equity Value is the sum of the present value of cash flows for the next ten years and the discounted terminal value. Dividing this value by the number of shares outstanding gives us the intrinsic value per share. Comparing this value to the current share price of the company, we can determine if the stock is undervalued or overvalued.
In the case of Worthington Industries, the DCF model suggests that the company is currently undervalued at a 43% discount to its intrinsic value. However, it’s important to note that valuations are imprecise instruments and can vary based on different assumptions.
The DCF model has certain limitations. It does not consider the cyclicality of an industry or a company’s future capital requirements, which may affect its performance. Additionally, the model relies on assumptions such as the discount rate and cash flows, which should be evaluated individually.
To gain a comprehensive understanding of the company’s potential performance, it’s important to consider other factors beyond just the valuation. Analyzing risks, future earnings growth, and the company’s business fundamentals can provide additional insights.
Overall, the DCF model is a useful tool to test assumptions and theories about a company’s valuation. However, it should not be the sole basis for making investment decisions. Conducting further research and analysis is crucial to make informed investment choices.
1. Discounted Cash Flow (DCF): A financial valuation method that estimates the intrinsic value of an investment by calculating the present value of projected cash flows.
2. Intrinsic Value: The true value of an asset or investment, based on its underlying characteristics and future cash flows.
3. Free Cash Flow (FCF): The cash a company generates after accounting for both operating and capital expenses.
4. Terminal Value: The value of an investment at the end of a defined period, assuming a constant growth rate.
5. Cost of Equity: The rate of return required by an investor to compensate for the risk associated with holding equity in a company.
6. Discount Rate: The rate used to determine the present value of future cash flows by accounting for the time value of money.
7. Levered Beta: A measure of a stock’s volatility compared to the market, adjusted for the company’s level of debt.
8. Gordon Growth Model: A method used to estimate the present value of a company’s future cash flows based on a constant growth rate.
Source: Simply Wall St analysis model and industry average beta of globally comparable companies.