Is PG fairly valued?
I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. To start off with we need to estimate the next five years of cash flows. Where possible I use analyst estimates, but when these aren’t available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. I then discount the sum of these cash flows to arrive at a present value estimate.
5-year cash flow forecast
|Levered FCF ($, Millions)||$10,767.70||$11,515.43||$11,735.00||$11,012.67||$10,334.80|
|Source||Analyst x9||Analyst x8||Analyst x5||Extrapolated @ (-6.16%)||Extrapolated @ (-6.16%)|
|Present Value Discounted @ 8.49%||$9,924.70||$9,782.93||$9,188.95||$7,948.21||$6,875.01|
Present Value of 5-year Cash Flow (PVCF)= $43,720
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.5%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 8.5%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = $10,335 × (1 + 2.5%) ÷ (8.5% – 2.5%) = $175,798
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = $175,798 / ( 1 + 8.5%)5 = $116,946
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is $160,666. 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 $63.73, which, compared to the current share price of $79.16, we see that Procter & Gamble is fair value, maybe slightly overvalued at the time of writing.
The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Procter & Gamble 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 8.5%, which is based on a levered beta of 0.8. 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.
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 PG, I’ve put together three relevant factors you should further research:
- Financial Health: Does PG 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 PG’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 PG? 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 NYSE every 6 hours. If you want to find the calculation for other stocks just search here.