A Look At The Intrinsic Value Of Ross Stores Inc (NASDAQ:ROST)

December 03, 2018

Does the December share price for Ross Stores Inc (NASDAQ:ROST) reflect it's really worth? Today, I will calculate the stock's intrinsic value by taking the foreast future cash flows of the company and discounting them back to today's value. This is done using the discounted cash flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. Please also note that this article was written in December 2018 so be sure check out the updated calculation by following the link below.

Check out our latest analysis for Ross Stores

The model

I'm 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 perpetual stable growth rate. To start off with we need to estimate 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 this to its value today and sum up the total to get the present value of these cash flows.

5-year cash flow forecast

	2019	2020	2021	2022	2023
Levered FCF ($, Millions)	$1.61k	$1.69k	$1.82k	$1.99k	$2.40k
Source	Analyst x8	Analyst x8	Analyst x5	Analyst x3	Analyst x2
Present Value Discounted @ 9.45%	$1.47k	$1.41k	$1.39k	$1.38k	$1.53k

Present Value of 5-year Cash Flow (PVCF)= US$7.2b

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 an annual growth rate equal to the 10-year government bond rate of 2.9%. We discount this to today's value at a cost of equity of 9.4%.

Terminal Value (TV) = FCF₂₀₂₂ × (1 + g) ÷ (r – g) = US$2.4b × (1 + 2.9%) ÷ (9.4% – 2.9%) = US$38b

Present Value of Terminal Value (PVTV) = TV / (1 + r)⁵ = US$38b ÷ ( 1 + 9.4%)⁵ = US$24b

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$31b. In the final step we 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) or ADR then we use the equivalent number. This results in an intrinsic value of $84.1. Relative to the current share price of $87.6, the stock is fair value, maybe slightly overvalued at the time of writing.

NasdaqGS:ROST Intrinsic Value Export December 3rd 18

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual 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 Ross Stores 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 9.4%, which is based on a levered beta of 0.922. 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.

Next Steps:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. For ROST, there are three key aspects you should further examine:

Financial Health: Does ROST 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 ROST'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 ROST? 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 NASDAQ every 6 hours. If you want to find the calculation for other stocks just search here.

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The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article 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.