Stock Analysis

Calculating The Intrinsic Value Of Winmark Corporation (NASDAQ:WINA)

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NasdaqGM:WINA
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Today we will run through one way of estimating the intrinsic value of Winmark Corporation (NASDAQ:WINA) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. 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. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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Is Winmark fairly valued?

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. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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) estimate

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Levered FCF ($, Millions) US$41.3m US$42.0m US$42.7m US$43.5m US$44.3m US$45.1m US$46.0m US$46.9m US$47.8m US$48.7m
Growth Rate Estimate Source Est @ 1.51% Est @ 1.65% Est @ 1.74% Est @ 1.81% Est @ 1.85% Est @ 1.89% Est @ 1.91% Est @ 1.92% Est @ 1.93% Est @ 1.94%
Present Value ($, Millions) Discounted @ 7.3% US$38.5 US$36.5 US$34.6 US$32.8 US$31.2 US$29.6 US$28.1 US$26.7 US$25.4 US$24.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$307m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 2.0%. We discount the terminal cash flows to today's value at a cost of equity of 7.3%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$49m× (1 + 2.0%) ÷ (7.3%– 2.0%) = US$933m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$933m÷ ( 1 + 7.3%)10= US$462m

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$769m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$252, the company appears around fair value at the time of writing. 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.

dcf
NasdaqGM:WINA Discounted Cash Flow December 1st 2021

The 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 Winmark 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 7.3%, which is based on a levered beta of 1.215. 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.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Winmark, we've compiled three important factors you should further examine:

  1. Risks: For example, we've discovered 3 warning signs for Winmark (1 is concerning!) that you should be aware of before investing here.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for WINA's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  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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