Stock Analysis

# An Intrinsic Calculation For The Coca-Cola Company (NYSE:KO) Suggests It's 29% Undervalued

•  Updated

In this article we are going to estimate the intrinsic value of The Coca-Cola Company (NYSE:KO) by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. 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.

See our latest analysis for Coca-Cola

### Step by step through 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 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 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\$10.7b US\$11.4b US\$11.7b US\$13.1b US\$13.8b US\$14.3b US\$14.7b US\$15.2b US\$15.6b US\$15.9b Growth Rate Estimate Source Analyst x9 Analyst x8 Analyst x5 Analyst x1 Analyst x1 Est @ 3.76% Est @ 3.21% Est @ 2.82% Est @ 2.55% Est @ 2.36% Present Value (\$, Millions) Discounted @ 5.3% US\$10.2k US\$10.2k US\$10.0k US\$10.7k US\$10.6k US\$10.5k US\$10.3k US\$10.0k US\$9.8k US\$9.5k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US\$102b

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 5.3%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US\$16b× (1 + 1.9%) ÷ (5.3%– 1.9%) = US\$478b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US\$478b÷ ( 1 + 5.3%)10= US\$285b

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\$387b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US\$63.1, the company appears a touch undervalued at a 29% 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.

### Important assumptions

We would 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 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 Coca-Cola 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 5.3%, which is based on a levered beta of 0.800. 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:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize 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. What is the reason for the share price sitting below the intrinsic value? For Coca-Cola, we've put together three pertinent factors you should explore:

1. Risks: You should be aware of the 2 warning signs for Coca-Cola we've uncovered before considering an investment in the company.
2. Future Earnings: How does KO'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 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. 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.

### Valuation is complex, but we're helping make it simple.

Find out whether Coca-Cola is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

View the Free Analysis