Stock Analysis

An Intrinsic Calculation For DICK'S Sporting Goods, Inc. (NYSE:DKS) Suggests It's 31% Undervalued

NYSE:DKS
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Key Insights

  • The projected fair value for DICK'S Sporting Goods is US$203 based on 2 Stage Free Cash Flow to Equity
  • DICK'S Sporting Goods' US$140 share price signals that it might be 31% undervalued
  • Our fair value estimate is 28% higher than DICK'S Sporting Goods' analyst price target of US$159

How far off is DICK'S Sporting Goods, Inc. (NYSE:DKS) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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.

See our latest analysis for DICK'S Sporting Goods

The Method

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. 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.

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) estimate

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Levered FCF ($, Millions) US$763.9m US$1.02b US$998.3m US$1.34b US$797.0m US$1.34b US$1.39b US$1.44b US$1.48b US$1.52b
Growth Rate Estimate Source Analyst x4 Analyst x5 Analyst x5 Analyst x3 Analyst x2 Analyst x2 Est @ 3.69% Est @ 3.21% Est @ 2.88% Est @ 2.65%
Present Value ($, Millions) Discounted @ 8.9% US$702 US$860 US$774 US$955 US$521 US$806 US$768 US$728 US$688 US$649

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$7.5b

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 (2.1%) 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 8.9%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$1.5b× (1 + 2.1%) ÷ (8.9%– 2.1%) = US$23b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$23b÷ ( 1 + 8.9%)10= US$9.8b

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$17b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$140, the company appears quite good value at a 31% 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.

dcf
NYSE:DKS Discounted Cash Flow May 11th 2023

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 DICK'S Sporting Goods 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 8.9%, which is based on a levered beta of 1.137. 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 DICK'S Sporting Goods

Strength
  • Debt is not viewed as a risk.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Earnings declined over the past year.
  • Dividend is low compared to the top 25% of dividend payers in the Specialty Retail market.
  • Shareholders have been diluted in the past year.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Annual earnings are forecast to grow slower than the American market.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. 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 DICK'S Sporting Goods, we've compiled three essential items you should further examine:

  1. Risks: For instance, we've identified 4 warning signs for DICK'S Sporting Goods (1 makes us a bit uncomfortable) you should be aware of.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for DKS'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.

Valuation is complex, but we're helping make it simple.

Find out whether DICK'S Sporting Goods is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.