Stock Analysis

# Does This Valuation Of JB Hi-Fi Limited (ASX:JBH) Imply Investors Are Overpaying?

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How far off is JB Hi-Fi Limited (ASX:JBH) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by projecting its future cash flows and then discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for JB Hi-Fi

### The calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:

#### 10-year free cash flow (FCF) estimate

 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 Levered FCF (A\$, Millions) AU\$503.9m AU\$530.0m AU\$443.7m AU\$314.0m AU\$326.0m AU\$285.9m AU\$263.0m AU\$249.7m AU\$242.3m AU\$238.7m Growth Rate Estimate Source Analyst x4 Analyst x4 Analyst x3 Analyst x1 Analyst x1 Est @ -12.29% Est @ -8.03% Est @ -5.05% Est @ -2.96% Est @ -1.49% Present Value (A\$, Millions) Discounted @ 8.0% AU\$467 AU\$454 AU\$352 AU\$231 AU\$222 AU\$180 AU\$153 AU\$135 AU\$121 AU\$111

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = AU\$2.4b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (1.9%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 8.0%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = AU\$239m× (1 + 1.9%) ÷ (8.0%– 1.9%) = AU\$4.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= AU\$4.0b÷ ( 1 + 8.0%)10= AU\$1.9b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is AU\$4.3b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of AU\$49.0, the company appears reasonably expensive at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

### The 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 these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at JB Hi-Fi 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've used 8.0%, which is based on a levered beta of 1.289. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

### Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value lower than the current share price? For JB Hi-Fi, we've compiled three essential items you should assess:

1. Risks: Take risks, for example - JB Hi-Fi has 2 warning signs (and 1 which can't be ignored) we think you should know about.
2. Future Earnings: How does JBH's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
3. Other Solid Businesses: 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 companies you may not have considered!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the ASX every day. If you want to find the calculation for other stocks just search here.

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### Valuation is complex, but we're helping make it simple.

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