Stock Analysis

Zimmer Biomet Holdings, Inc.'s (NYSE:ZBH) Intrinsic Value Is Potentially 62% Above Its Share Price

  •  Updated
NYSE:ZBH
Source: Shutterstock

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Zimmer Biomet Holdings, Inc. (NYSE:ZBH) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. 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 Zimmer Biomet Holdings

The model

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 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Levered FCF ($, Millions) US$868.3m US$1.66b US$1.93b US$2.15b US$2.43b US$2.64b US$2.81b US$2.96b US$3.08b US$3.19b
Growth Rate Estimate Source Analyst x4 Analyst x4 Analyst x4 Analyst x3 Analyst x2 Est @ 8.47% Est @ 6.53% Est @ 5.17% Est @ 4.21% Est @ 3.55%
Present Value ($, Millions) Discounted @ 6.6% US$814 US$1.5k US$1.6k US$1.7k US$1.8k US$1.8k US$1.8k US$1.8k US$1.7k US$1.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$16b

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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 6.6%.

Terminal Value (TV)= FCF2030 × (1 + g) ÷ (r – g) = US$3.2b× (1 + 2.0%) ÷ (6.6%– 2.0%) = US$71b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$71b÷ ( 1 + 6.6%)10= US$37b

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$53b. 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$158, the company appears quite undervalued at a 38% 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:ZBH Discounted Cash Flow June 8th 2021

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Zimmer Biomet Holdings 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 6.6%, which is based on a levered beta of 0.978. 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. 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. 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 Zimmer Biomet Holdings, we've compiled three pertinent aspects you should explore:

  1. Risks: Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Zimmer Biomet Holdings (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for ZBH's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  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.

If you decide to trade Zimmer Biomet Holdings, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted


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

Find out whether Zimmer Biomet Holdings 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