A Look At The Fair Value Of Avis Budget Group Inc (NASDAQ:CAR)

I am going to run you through how I calculated the intrinsic value of Avis Budget Group Inc (NASDAQ:CAR) by taking the expected future cash flows and discounting them to their present value. This is done using the Discounted Cash Flows (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward. 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 2017 so be sure check out the updated calculation by following the link below. View our latest analysis for Avis Budget Group

The method

I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. To begin with we have to get estimates of the next five years of cash flows. Where possible I use analyst estimates, but when these aren't available I have extrapolated the previous free cash flow (FCF) from the year before. For this growth rate I used the average annual growth rate over the past five years, but capped at a reasonable level. I then discount this to its value today and sum up the total to get the present value of these cash flows.

After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond 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 2.5%. We discount this to today's value at a cost of equity of 16.5%.

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is $3,447. To get the intrinsic value per share, we divide this by the total number of shares outstanding, or the equivalent number if this is a depositary receipt or ADR. This results in an intrinsic value of $42.33, which, compared to the current share price of $45.16, we find that Avis Budget Group is fair value, maybe slightly overvalued and not available at a discount at this time.

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 Avis Budget Group 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 16.5%, which is based on a levered beta of 1.857. 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:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company. For CAR, I've compiled three key factors you should further research:

1. Financial Health: Does CAR 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.

2. Future Earnings: How does CAR'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.

2. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of CAR? 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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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.