Yahoo Autos General Dynamics Corporation's (NYSE:GD) Intrinsic Value Is Potentially 48% Above Its Share Price
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of General Dynamics Corporation (NYSE:GD) as an investment opportunity by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
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 General Dynamics
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. 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, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) forecast
2021 | 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | |
Levered FCF ($, Millions) | US$3.09b | US$3.42b | US$3.68b | US$3.81b | US$4.06b | US$4.24b | US$4.40b | US$4.54b | US$4.67b | US$4.79b |
Growth Rate Estimate Source | Analyst x3 | Analyst x8 | Analyst x7 | Analyst x3 | Analyst x1 | Est @ 4.44% | Est @ 3.72% | Est @ 3.21% | Est @ 2.86% | Est @ 2.62% |
Present Value ($, Millions) Discounted @ 7.6% | US$2.9k | US$3.0k | US$3.0k | US$2.8k | US$2.8k | US$2.7k | US$2.6k | US$2.5k | US$2.4k | US$2.3k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$27b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 7.6%.
