Intrinsic calculation for Danaher Corporation (NYSE: DHR) suggests it’s 26% undervalued
Today we are going to review a valuation method used to estimate the attractiveness of Danaher Corporation (NYSE: DHR) as an investment opportunity by taking the company’s future cash flow forecast and by updating them to today’s value. One way to do this is to use the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too hard to follow, as you will see in our example!
Keep in mind, however, that there are many ways to estimate the value of a business, and a DCF is just one method. For those who are passionate about equity analysis, the Simply Wall St analysis template here may be something that interests you.
Step by step in the calculation
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. In the first step, we have 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 last 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.
In general, we assume that a dollar today is worth more than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today’s dollars:
10-year Free Cash Flow (FCF) estimate
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Leverage FCF ($, Millions) | 6.47 billion US dollars | US $ 6.95 billion | 7.38 billion US dollars | 8.97 billion US dollars | US $ 10.0 billion | US $ 10.8 billion | US $ 11.5 billion | US $ 12.1 billion | US $ 12.5 billion | US $ 13.0 billion |
Source of growth rate estimate | Analyst x8 | Analyst x8 | Analyst x8 | Analyst x2 | Analyst x2 | Est @ 7.86% | Is 6.1% | Est @ 4.87% | Is @ 4% | Is 3.4% |
Present value (in millions of dollars) discounted at 6.3% | US $ 6.1,000 | US $ 6.1,000 | US $ 6.1,000 | US $ 7,000 | $ 7.4,000 | 7.5,000 USD | 7.5,000 USD | $ 7.4,000 | $ 7.2,000 | US $ 7,000 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 69 billion
The second stage is also known as terminal value, this is the cash flow of the business after 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 of 2.0%. We discount the terminal cash flows to their present value at a cost of equity of 6.3%.
Terminal value (TV)= FCF_{2030} × (1 + g) ÷ (r – g) = US $ 13B × (1 + 2.0%) ÷ (6.3% – 2.0%) = US $ 305B
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= 305 billion US dollars ÷ (1 + 6.3%)^{ten}= 165 billion US dollars
Total value, or net worth, is then the sum of the present value of future cash flows, which in this case is US $ 235 billion. The last step is then to divide the equity value by the number of shares outstanding. From the current share price of US $ 242, the company appears to be slightly undervalued with a 26% discount from the current share price. Remember, however, that this is only a rough estimate, and like any complex formula – trash in, trash out.
NYSE: DHR Discounted Cash Flow June 5, 2021
The hypotheses
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 Danaher 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 6.3%, which is based on a leveraged beta of 0.917. 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 :
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a business. It is not possible to achieve a rock-solid valuation with a DCF model. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. 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. Why is intrinsic value greater than the current share price? For Danaher, you have to assess three fundamental aspects:
- Risks: You should be aware of the 2 warning signs for Danaher we found out before considering an investment in the business.
- Management: Have insiders increased their stocks to take advantage of market sentiment about DHR’s future prospects? Check out our management and board analysis with information on CEO compensation and governance factors.
- Other strong companies: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other businesses you may not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for every NYSE share. If you want to find the calculation for other actions just search here.
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 any of the stocks mentioned.
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