Is Stanley Black & Decker, Inc. (NYSE:SWK) Trading At A 36% Discount?

September 29, 2022
  •  Updated
October 04, 2022
NYSE:SWK
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Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Stanley Black & Decker, Inc. (NYSE:SWK) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Stanley Black & Decker

Step By Step Through The Calculation

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, 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

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF ($, Millions) US$1.62b US$1.28b US$1.14b US$1.36b US$1.30b US$1.27b US$1.26b US$1.25b US$1.26b US$1.27b
Growth Rate Estimate Source Analyst x8 Analyst x5 Analyst x1 Analyst x1 Est @ -4.2% Est @ -2.36% Est @ -1.07% Est @ -0.17% Est @ 0.47% Est @ 0.91%
Present Value ($, Millions) Discounted @ 8.1% US$1.5k US$1.1k US$903 US$994 US$880 US$795 US$727 US$672 US$624 US$582

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$8.8b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 8.1%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$1.3b× (1 + 1.9%) ÷ (8.1%– 1.9%) = US$21b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$21b÷ ( 1 + 8.1%)10= US$9.6b

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$18b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$79.6, the company appears quite undervalued at a 36% discount to where the stock price trades currently. 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.

dcf
NYSE:SWK Discounted Cash Flow September 29th 2022

The Assumptions

Now 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 inputs, I recommend redoing the calculations yourself and playing with them. 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 Stanley Black & Decker 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 8.1%, which is based on a levered beta of 1.458. 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.

Next Steps:

Whilst important, the DCF calculation 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For Stanley Black & Decker, we've compiled three fundamental elements you should further research:

  1. Risks: Every company has them, and we've spotted 4 warning signs for Stanley Black & Decker (of which 1 is significant!) you should know about.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SWK's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  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 NYSE every day. If you want to find the calculation for other stocks just search here.

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