How far is DICK’S Sporting Goods, Inc. (NYSE: DKS) from its intrinsic value? Using the latest financial data, we check if the stock is fairly valued by forecasting its future cash flows and then discounting it to today’s value. This is done according to the discounted cash flow (DCF) model. Don’t let the jargon put you off, the math behind it is actually pretty simple.
Remember, however, that there are many ways to appreciate a company’s value, and a DCF is just one method. If you want to know more about the discounted cash flow, you can read the reasons for this calculation in detail in the Simply Wall St analysis model.
Check out our latest analysis for DICK’S Sporting Goods
We’re going to be using a two-tier DCF model that, as the name suggests, takes into account two stages of growth. The first phase is generally a higher growth phase that flattens out towards the final value captured in the second phase of “steady growth”. First, we need to estimate the cash flows for the next ten years. We use analyst estimates whenever possible, but when these are not available we extrapolate the previous free cash flow (FCF) from the most recent estimate or reported value. We assume that companies with falling free cash flow will slow their rate of contraction and that companies with increasing free cash flow will slow their growth rate over this period. We do this to take into account that growth tends to slow down more in the first few years than in later years.
A DCF is all about the idea that a dollar in the future is worth less than a dollar today, and so the sum of those future cash flows is discounted to today’s value:
10-year free cash flow (FCF) forecast
|Levered FCF ($, million)||$ 1.14 billion||$ 762.1 million||$ 895.9 million||$ 806.5 million||$ 909.5 million||$ 941.5 million||$ 970.4 million||$ 997.0 million||$ 1.02 billion||$ 1.05 billion|
|Source of growth rate estimate||Analyst x8||Analyst x8||Analyst x3||Analyst x2||Analyst x2||Estimated at 3.52%||Estimated @ 3.06%||Estimate @ 2.74%||Estimated at 2.52%||Estimated @ 2.36%|
|Present Value ($, Million) Discounted @ 8.6%||$ 1.0,000||$ 646||$ 700||$ 580||$ 603||$ 575||$ 545||$ 516||$ 487||$ 459|
(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = $ 6.2 billion
After calculating the present value of future cash flows in the first 10 year period, we need to calculate the terminal value that takes into account all future cash flows beyond the first tier. The Gordon Growth Formula is used to calculate the terminal value using 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 today’s value using a cost of equity of 8.6%.
Final value (TV)= FCF2031 × (1 + g) ÷ (r – g) = $ 1.0 billion × (1 + 2.0%) ÷ (8.6% – 2.0%) = $ 16 billion
Present value of the final value (PVTV)= TV / (1 + r) 10 = US $ 16 billion ÷ (1 + 8.6%) 10 = US $ 7.1 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $ 13 billion. The final step is to divide the stock value by the number of shares outstanding. Based on the current share price of 131 US dollars, the company appears to be fair value with a discount of 13% on the current share price. Ratings, however, are inaccurate instruments, much like a telescope – move a few degrees and land in a different galaxy. Keep this in mind.
NYSE: DKS Discounted Cash Flow September 28, 2021
The above calculation depends heavily on two assumptions. The first is the discount rate and the other is the cash flows. If you do not agree with this result, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclical nature of an industry or the future capital requirements of a company, so that it does not provide a complete picture of the potential performance of a company. Since we consider DICK’S Sporting Goods 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 accounts for debt. In this calculation we used 8.6% which is based on a debt beta of 1.396. Beta is a measure of the volatility of a stock compared to the overall market. We get our beta from the industry standard beta from globally comparable companies with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Rating is only one side of the coin when it comes to creating your investment thesis, and it’s just one of many factors that you need to evaluate for a company. A foolproof valuation is not possible with a DCF model. Rather, it should be viewed as a guide to “what assumptions must be true for this stock to be undervalued / overvalued?” If a company is growing differently, or if the cost of equity or the risk-free interest rate changes dramatically, the outcome may be very different. For DICK’S Sporting Goods, we’ve rounded up three essential items that you should explore:
- Risks: For example, we discovered 4 warning signs for DICK’S Sporting Goods (1 shouldn’t be ignored!) To Consider Before Investing Here.
- administration: Did insiders increase their shares to use market sentiment for future prospects for DKS? Check out our management and board analysis with insights into CEO compensation and governance factors.
- Other solid deals: Low debt, high returns on equity, and good past performance are fundamental to a strong business. Explore our interactive list of stocks with a solid business foundation to see if there are any other companies you might not have considered!
PS. Simply Wall St updates its DCF calculation for every American share daily. So if you want to find out the intrinsic value of any other stock, just search here.
This article from Simply Wall St is of a general nature. We only provide comments based on historical data and analyst projections using an unbiased methodology, and our articles are not intended as financial advice. It is not a recommendation to buy or sell stocks and does not take into account your goals or your financial situation. Our goal is to provide you with long-term, focused analysis based on fundamentals. Note that our analysis may not take into account the latest company announcements or quality material, which may be sensitive to the price. Simply Wall St has no position in the stocks mentioned.
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