Are Investors Undervaluing Charter Communications, Inc. (NASDAQ:CHTR) By 20%?

Key Insights

• Charter Communications' estimated fair value is US$496 based on 2 Stage Free Cash Flow to Equity
• Current share price of US$394 suggests Charter Communications is 20% undervalued
• Analyst price target for CHTR is US$461 which is 6.9% below our fair value estimate

Today we will run through one way of estimating the intrinsic value of Charter Communications, Inc. (NASDAQ:CHTR) by projecting its future cash flows and then 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!

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. 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.

View our latest analysis for Charter Communications

Step By Step Through The Calculation

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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2023	2024	2025	2026	2027	2028	2029	2030	2031	2032
Levered FCF ($, Millions)	US$5.01b	US$5.26b	US$5.85b	US$8.29b	US$8.37b	US$8.47b	US$8.59b	US$8.73b	US$8.88b	US$9.04b
Growth Rate Estimate Source	Analyst x14	Analyst x14	Analyst x8	Analyst x6	Analyst x4	Est @ 1.21%	Est @ 1.44%	Est @ 1.60%	Est @ 1.72%	Est @ 1.80%
Present Value ($, Millions) Discounted @ 10%	US$4.5k	US$4.3k	US$4.4k	US$5.6k	US$5.1k	US$4.7k	US$4.3k	US$4.0k	US$3.7k	US$3.4k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$44b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.0%) 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 10%.

Terminal Value (TV)= FCF₂₀₃₂ × (1 + g) ÷ (r – g) = US$9.0b× (1 + 2.0%) ÷ (10%– 2.0%) = US$111b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$111b÷ ( 1 + 10%)¹⁰= US$42b

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$86b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$394, the company appears a touch undervalued at a 20% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

Important Assumptions

Now 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 Charter Communications 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 10%, which is based on a levered beta of 1.379. 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.

SWOT Analysis for Charter Communications

Looking Ahead:

Although the valuation of a company is important, it is only one of many factors that you need to assess for 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?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price sitting below the intrinsic value? For Charter Communications, there are three essential aspects you should consider:

1. Risks: As an example, we've found 1 warning sign for Charter Communications that you need to consider before investing here.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CHTR'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 NASDAQGS every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.