Is Installed Building Products, Inc. (NYSE:IBP) Trading At A 38% Discount?

By
Simply Wall St
Published
March 22, 2022
NYSE:IBP
Source: Shutterstock

Does the March share price for Installed Building Products, Inc. (NYSE:IBP) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

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 Installed Building Products

Crunching the numbers

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 discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF ($, Millions) US$188.0m US$212.5m US$243.0m US$266.0m US$283.0m US$297.3m US$309.6m US$320.3m US$329.9m US$338.7m
Growth Rate Estimate Source Analyst x5 Analyst x5 Analyst x1 Analyst x1 Est @ 6.4% Est @ 5.06% Est @ 4.11% Est @ 3.46% Est @ 3% Est @ 2.67%
Present Value ($, Millions) Discounted @ 7.7% US$175 US$183 US$195 US$198 US$196 US$191 US$185 US$177 US$170 US$162

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$1.8b

The second stage is also known as Terminal Value, this is the business's cash flow after 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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 7.7%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$339m× (1 + 1.9%) ÷ (7.7%– 1.9%) = US$6.0b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$6.0b÷ ( 1 + 7.7%)10= US$2.9b

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$4.7b. 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$98.3, the company appears quite undervalued at a 38% 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:IBP Discounted Cash Flow March 22nd 2022

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Installed Building Products 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 7.7%, which is based on a levered beta of 1.356. 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 shouldn't be the only metric you look at when researching 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?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Can we work out why the company is trading at a discount to intrinsic value? For Installed Building Products, we've compiled three further aspects you should further examine:

  1. Risks: Case in point, we've spotted 2 warning signs for Installed Building Products you should be aware of, and 1 of them doesn't sit too well with us.
  2. Future Earnings: How does IBP'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.

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