The calculation
I’m 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 perpetual stable growth rate. To start off with we need to estimate the next five years of cash flows. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.
5-year cash flow estimate
| 2018 | 2019 | 2020 | 2021 | 2022 | |
| Levered FCF ($, Millions) | $2,894.11 | $3,209.20 | $3,544.00 | $4,546.00 | $5,088.00 |
| Source | Analyst x7 | Analyst x6 | Analyst x2 | Analyst x1 | Analyst x1 |
| Present Value Discounted @ 9.03% | $2,654.52 | $2,699.83 | $2,734.66 | $3,217.43 | $3,302.91 |
Present Value of 5-year Cash Flow (PVCF)= $14,609
After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.5%. We discount this to today’s value at a cost of equity of 9%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = $5,088 × (1 + 2.5%) ÷ (9% – 2.5%) = $79,525
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = $79,525 / ( 1 + 9%)5 = $51,625
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is $66,234. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of $47.12, which, compared to the current share price of $57.71, we find that Starbucks is fair value, maybe slightly overvalued at the time of writing.
Important assumptions
I’d like to point out that 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 my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Starbucks as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 9%, which is based on a levered beta of 0.871. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Next Steps:
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For SBUX, I’ve put together three essential factors you should look at:
- Financial Health: Does SBUX have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does SBUX’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.
- Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of SBUX? 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 for every stock on the NASDAQ every 6 hours. If you want to find the calculation for other stocks just search here.