Estimating The Intrinsic Value Of Parker-Hannifin Corporation (NYSE:PH)

February 24, 2021
  •  Updated
August 16, 2022
NYSE:PH
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How far off is Parker-Hannifin Corporation (NYSE:PH) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. 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. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for Parker-Hannifin

What's the estimated valuation?

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 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, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF ($, Millions) US$2.07b US$2.14b US$2.37b US$2.58b US$2.71b US$2.82b US$2.91b US$2.99b US$3.07b US$3.15b
Growth Rate Estimate Source Analyst x11 Analyst x11 Analyst x9 Analyst x3 Analyst x1 Est @ 3.77% Est @ 3.25% Est @ 2.89% Est @ 2.63% Est @ 2.46%
Present Value ($, Millions) Discounted @ 8.0% US$1.9k US$1.8k US$1.9k US$1.9k US$1.8k US$1.8k US$1.7k US$1.6k US$1.5k US$1.5k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$17b

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 8.0%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$3.1b× (1 + 2.0%) ÷ (8.0%– 2.0%) = US$54b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$54b÷ ( 1 + 8.0%)10= US$25b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$43b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$297, the company appears about fair value at a 9.9% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
NYSE:PH Discounted Cash Flow February 25th 2021

The assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Parker-Hannifin 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 1.137. 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.

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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. For Parker-Hannifin, we've put together three further elements you should further research:

  1. Risks: You should be aware of the 1 warning sign for Parker-Hannifin we've uncovered before considering an investment in the company.
  2. Future Earnings: How does PH'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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

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About NYSE:PH

Parker-Hannifin

Parker-Hannifin Corporation manufactures and sells motion and control technologies and systems for various mobile, industrial, and aerospace markets worldwide.

Established dividend payer with adequate balance sheet.