How far off is Danaher (NYSE:DHR) to its intrinsic value? I am going to take a look now using a method called discounted cash flow or DCF. Discounted cash flow (DCF) is a valuation method used to estimate the attractiveness of an investment opportunity by taking the expected Future Cash Flows and discounting them to their present valye. It sounds complicated, but actually it is quite simple!
If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model.
If you are reading this and its not July 2017 then I highly recommend you check out the latest calculation for Danaher by following the link below. View our latest analysis for Danaher
I use what is known as a 2-stage model, which simply means we have two different periods where we need to estimate cash flows. In the 1st stage we need to estimate the cash flows to the business over the next 5 years, for this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
Detailed calculation
Please note that the numbers here are in millions apart from the per share values.
5-year cash flow forecast
2017 | 2018 | 2019 | 2020 | 2021 | |
Levered FCF (USD, Millions) | $2,714.16 | $3,160.43 | $3,368.78 | $3,461.00 | $3,702.00 |
Source | Analyst x8 | Analyst x9 | Analyst x5 | Analyst x1 | Analyst x1 |
Present Value Discounted @ 8.47% | $2,502.32 | $2,686.32 | $2,639.93 | $2,500.50 | $2,465.86 |
Present value of next 5 years cash flows: $12,795
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the 5 years. The Perpetuity Method (Gordon Formula) is used to calculate Terminal Value at an annual growth rate equal to the 10 year government bond rate of (2.3%).
Terminal Value
Terminal Value = FCF_{2021} × (1 + g) ÷ (Discount Rate – g)
Terminal Value = $3,702 × (1 + 2.3%) ÷ (8.5% – 2.3%)
Terminal value based on the Perpetuity Method where growth (g) = 2.3%: $61,738
Present value of terminal value: $41,123
The total value or equity value is then the sum of of the present value of the cash flows.
Equity Value
Equity Value (Total value) = Present value of next 5 years cash flows + terminal value = $12,795 + $41,123 = $53,918
To get the intrinsic value we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR to get the intrinsic value per share.
Value = Total value / Shares Outstanding ($53,918.03 / 691.61)
Value per share: $77.96
To finish off with if we compare the intrinsic value of 77.96 to the current share price of $85.79 we see Danaher (NYSE:DHR) is slightly overvalued at the time of writing.
Important assumptions
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Danaher as potential investors the Cost of Equity is used as the discount rate, not the Cost of Capital (or Weighed Average Cost of Capital/ WACC) which accounts for debt.
In this calculation I’ve used 8.5% and this is based on a Levered Beta of 0.8. I’m not going to go into how I calculate the Levered Beta in detail, I used the ‘Bottom up Beta’ method based on the comparable businesses, I also impose a limit between 0.8 and 2 which is a reasonable range for a stable business. Google this if you want to learn more.
Conclusion
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. Is Danaher in a healthy financial condition? What is the reason for the share price to differ from the intrinsic value? See our latest FREE analysis to find out!
PS. Simply Wall St does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.