Stock Analysis

DICK'S Sporting Goods, Inc. (NYSE:DKS) Shares Could Be 34% Below Their Intrinsic Value Estimate

NYSE:DKS
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Key Insights

  • The projected fair value for DICK'S Sporting Goods is US$336 based on 2 Stage Free Cash Flow to Equity
  • Current share price of US$221 suggests DICK'S Sporting Goods is potentially 34% undervalued
  • Our fair value estimate is 41% higher than DICK'S Sporting Goods' analyst price target of US$239

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of DICK'S Sporting Goods, Inc. (NYSE:DKS) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

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. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for DICK'S Sporting Goods

Crunching The Numbers

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF ($, Millions) US$891.9m US$745.5m US$1.05b US$966.2m US$1.32b US$1.53b US$1.69b US$1.82b US$1.94b US$2.04b
Growth Rate Estimate Source Analyst x8 Analyst x7 Analyst x7 Analyst x3 Analyst x1 Analyst x1 Est @ 10.27% Est @ 7.90% Est @ 6.24% Est @ 5.09%
Present Value ($, Millions) Discounted @ 7.7% US$828 US$642 US$836 US$718 US$910 US$980 US$1.0k US$1.0k US$992 US$967

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$8.9b

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 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 7.7%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$2.0b× (1 + 2.4%) ÷ (7.7%– 2.4%) = US$39b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$39b÷ ( 1 + 7.7%)10= US$19b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$27b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$221, the company appears quite good value at a 34% 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.

dcf
NYSE:DKS Discounted Cash Flow June 5th 2024

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 these result, have a go at the calculation yourself and play with the assumptions. 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 7.7%, which is based on a levered beta of 1.161. 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.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
  • Trading below our estimate of fair value by more than 20%.
Threat
  • Annual earnings are forecast to grow slower than the American market.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a discount to intrinsic value? For DICK'S Sporting Goods, there are three pertinent aspects you should assess:

  1. Risks: Case in point, we've spotted 1 warning sign for DICK'S Sporting Goods you should be aware of.
  2. Future Earnings: How does DKS'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 High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

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.

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.