Today we are going to do a simple overview of a valuation method used to estimate the attractiveness of Matthews International Corporation (NASDAQ:MATW) as an investment opportunity by taking future cash flows of the company and discounting them to the present value. On this occasion, we will use the Discounted Cash Flow (DCF) model. Don’t be put off by the jargon, the underlying calculations are actually quite simple.
Remember though 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 assessment, take a look at the Simply Wall St Analysis Template.
What is the estimated valuation?
We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. To begin with, we need to obtain cash flow estimates for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported 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 more in early years than in later years.
Generally, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:
10-Year Free Cash Flow (FCF) Forecast
|Leveraged FCF ($, millions)||$44.8 million||$116.9 million||$100.1 million||$90.7 million||$85.2 million||$82.1 million||$80.4 million||$79.8 million||$79.8 million||$80.3 million|
|Growth rate estimate Source||Analyst x1||Analyst x1||East @ -14.34%||Is @ -9.46%||Is @ -6.05%||Is @ -3.66%||Is @ -1.98%||Is @ -0.81%||Is 0.01%||Is at 0.58%|
|Present value (in millions of dollars) discounted at 7.6%||$41.6||$101||$80.4||$67.6||$59.0||$52.9||$48.2||$44.4||$41.2||$38.6|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $574 million
We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (1.9%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 7.6%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = $80 million × (1 + 1.9%) ÷ (7.6%–1.9%) = $1.4 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= $1.4 billion ÷ (1 + 7.6%)ten= $691 million
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $1.3 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of $33.5, the company appears to be about fair value at a 16% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
Now, 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, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Matthews International 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 7.6%, which is based on a leveraged beta of 1.341. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
Although the valuation of a business is important, it will ideally not be the only piece of analysis you will look at for a business. The DCF model is not a perfect stock 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 company grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output may be very different. For Matthews International, we’ve compiled three relevant things you need to assess:
- Risks: You should be aware of the 2 warning signs for Matthews International (1 does not suit us too much!) that we discovered before considering an investment in the company.
- Future earnings: How does MATW’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other businesses you may not have considered!
PS. The Simply Wall St app performs a daily updated cash flow assessment for each NASDAQGS stock. If you want to find the calculation for other stocks just search here.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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