A Look At The Fair Value Of Waters Corporation (NYSE:WAT)

Key Insights

• The projected fair value for Waters is US$399 based on 2 Stage Free Cash Flow to Equity
• With US$342 share price, Waters appears to be trading close to its estimated fair value
• Our fair value estimate is 18% higher than Waters' analyst price target of US$338

Today we will run through one way of estimating the intrinsic value of Waters Corporation (NYSE:WAT) by estimating the company's future cash flows and discounting them to their present value. This will be done using the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. 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 Waters

The Model

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 need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF ($, Millions)	US$809.1m	US$757.3m	US$916.0m	US$967.1m	US$1.01b	US$1.05b	US$1.09b	US$1.13b	US$1.16b	US$1.19b
Growth Rate Estimate Source	Analyst x4	Analyst x3	Analyst x1	Est @ 5.58%	Est @ 4.66%	Est @ 4.01%	Est @ 3.56%	Est @ 3.24%	Est @ 3.02%	Est @ 2.86%
Present Value ($, Millions) Discounted @ 6.4%	US$760	US$668	US$760	US$753	US$741	US$724	US$704	US$683	US$661	US$639

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$7.1b

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 2.5%. We discount the terminal cash flows to today's value at a cost of equity of 6.4%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = US$1.2b× (1 + 2.5%) ÷ (6.4%– 2.5%) = US$31b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$31b÷ ( 1 + 6.4%)¹⁰= US$17b

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$24b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$342, the company appears about fair value at a 14% 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 Waters 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 6.4%, which is based on a levered beta of 0.957. 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 Waters

Moving On:

Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. 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. For Waters, we've put together three important items you should further research:

1. Risks: For instance, we've identified 1 warning sign for Waters that you should be aware of.
2. Future Earnings: How does WAT'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.

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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.