Is Otis Worldwide Corporation (NYSE:OTIS) Worth US$81.8 Based On Its Intrinsic Value?

Key Insights

• Otis Worldwide's estimated fair value is US$66.6 based on 2 Stage Free Cash Flow to Equity
• Current share price of US$81.8 suggests Otis Worldwide is 23% overvalued
• Analyst price target for OTIS is US$78.58 which is 18% above our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Otis Worldwide Corporation (NYSE:OTIS) as an investment opportunity by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Otis Worldwide

The Calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of 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) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	US$1.62b	US$1.69b	US$1.89b	US$1.95b	US$2.00b	US$2.05b	US$2.09b	US$2.14b	US$2.18b	US$2.23b
Growth Rate Estimate Source	Analyst x8	Analyst x6	Analyst x2	Analyst x1	Est @ 2.56%	Est @ 2.38%	Est @ 2.26%	Est @ 2.18%	Est @ 2.12%	Est @ 2.08%
Present Value ($, Millions) Discounted @ 8.6%	US$1.5k	US$1.4k	US$1.5k	US$1.4k	US$1.3k	US$1.2k	US$1.2k	US$1.1k	US$1.0k	US$978

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$13b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate 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 today's value at a cost of equity of 8.6%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$2.2b× (1 + 2.0%) ÷ (8.6%– 2.0%) = US$34b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$34b÷ ( 1 + 8.6%)¹⁰= US$15b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$28b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$81.8, the company appears slightly overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own 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 Otis Worldwide 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 8.6%, which is based on a levered beta of 1.100. 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.

SWOT Analysis for Otis Worldwide

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for 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 significantly impact the valuation. Why is the intrinsic value lower than the current share price? For Otis Worldwide, we've compiled three important factors you should look at:

1. Risks: Every company has them, and we've spotted 2 warning signs for Otis Worldwide (of which 1 is a bit unpleasant!) you should know about.
2. Future Earnings: How does OTIS'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 High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

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

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.