Does Carrier Global Corporation’s (NYSE:CARR) stock price in September reflect what it’s really worth? Today we are going to estimate the intrinsic value of the stock by taking the expected future cash flows and discounting them to the present value. On this occasion, we will use the Discounted Cash Flow (DCF) model. Before you think you can’t figure it out, just read on! It’s actually a lot less complex than you might imagine.
We draw your attention to the fact that there are many ways to value a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are passionate about stock analysis, the Simply Wall St analysis template here may interest you.
Check out our latest analysis for Carrier Global
We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. 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.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we discount the value of these future cash flows to their estimated value in today’s dollars:
Estimated free cash flow (FCF) over 10 years
|Leveraged FCF ($, millions)||$1.98 billion||US$2.29 billion||$2.78 billion||$2.84 billion||$2.89 billion||$2.94 billion||US$3,000,000,000||US$3.06 billion||US$3.12 billion||US$3.18 billion|
|Growth rate estimate Source||Analyst x11||Analyst x3||Analyst x1||Analyst x1||Is at 1.89%||Is at 1.91%||Is at 1.92%||Is at 1.92%||Is at 1.93%||Is at 1.93%|
|Present value (millions of dollars) discounted at 7.0%||$1.8,000||$2,000||$2,300||$2,200||$2,100||$2,000||$1,900||$1.8,000||$1.7,000||$1,600|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $19 billion
After calculating the present value of future cash flows over the initial 10-year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first stage. 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 7.0%.
Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$3.2 billion × (1 + 1.9%) ÷ (7.0%–1.9%) = US$64 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= $64 billion ÷ (1 + 7.0%)ten= $32 billion
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $51 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of $42.2, the company appears to be pretty good value at a 31% discount to the current share price. The assumptions of any calculation have a big impact on the valuation, so it’s best to consider this as a rough estimate, not accurate down to the last penny.
We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play around with them. 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 complete picture of a company’s potential performance. Since we view Carrier Global 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 factors in debt. In this calculation, we used 7.0%, which is based on a leveraged beta of 1.201. 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 a business valuation is important, it is only one of many factors you need to assess for a business. It is not possible to obtain an infallible 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 the company being undervalued or overvalued. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. Why is the stock price below intrinsic value? For Carrier Global, we’ve put together three important factors you should explore:
- Risks: For example, we discovered 3 warning signs for Carrier Global (2 are concerning!) that you should be aware of before investing here.
- Future earnings: How does CARR’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 companies you may not have considered!
PS. The Simply Wall St app performs a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks, 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.
Calculation of discounted cash flows for each share
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