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 begin with we have to get estimates of 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
|Levered FCF ($, Millions)||$18,516.67||$18,755.30||$19,459.57||$23,743.00||$25,786.50|
|Source||Analyst x6||Analyst x5||Analyst x4||Analyst x2||Analyst x2|
|Present Value Discounted @ 8.49%||$17,067.00||$15,933.55||$15,237.58||$17,136.13||$17,153.94|
Present Value of 5-year Cash Flow (PVCF)= $82,528
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. 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 8.5%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = $25,787 × (1 + 2.5%) ÷ (8.5% – 2.5%) = $438,636
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = $438,636 / ( 1 + 8.5%)5 = $291,793
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 $374,322. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of $62.93, which, compared to the current share price of $35.49, we find that Pfizer is quite undervalued at a 43.60% discount to what it is available for right now.
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 Pfizer 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 PFE, there are three important aspects you should look at:
- Financial Health: Does PFE 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 PFE’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 PFE? 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.