Yahoo Finance A Look At The Fair Value Of International Business Machines Corporation (NYSE:IBM)
Key Insights
Using the 2 Stage Free Cash Flow to Equity, International Business Machines fair value estimate is US$120
Current share price of US$132 suggests International Business Machines is potentially trading close to its fair value
The US$139 analyst price target for IBM is 15% more than our estimate of fair value
How far off is International Business Machines Corporation (NYSE:IBM) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Believe it or not, it's not too difficult to follow, as you'll see from our example!
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
View our latest analysis for International Business Machines
The Model
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Levered FCF ($, Millions) | US$10.9b | US$10.2b | US$9.87b | US$9.69b | US$9.63b | US$9.65b | US$9.73b | US$9.84b | US$9.99b | US$10.2b |
Growth Rate Estimate Source | Analyst x2 | Analyst x1 | Est @ -3.45% | Est @ -1.78% | Est @ -0.61% | Est @ 0.20% | Est @ 0.78% | Est @ 1.18% | Est @ 1.46% | Est @ 1.65% |
Present Value ($, Millions) Discounted @ 10% | US$9.9k | US$8.4k | US$7.4k | US$6.6k | US$5.9k | US$5.4k | US$4.9k | US$4.5k | US$4.2k | US$3.8k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$61b
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. 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 10%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$10b× (1 + 2.1%) ÷ (10%– 2.1%) = US$128b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$128b÷ ( 1 + 10%)10= US$48b
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$109b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$132, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
Important Assumptions
Now 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 International Business Machines 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 10%, which is based on a levered beta of 1.364. 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 International Business Machines
Strength
Debt is well covered by earnings.
Weakness
Earnings declined over the past year.
Dividend is low compared to the top 25% of dividend payers in the IT market.
Expensive based on P/E ratio and estimated fair value.
Opportunity
Annual earnings are forecast to grow faster than the American market.
Threat
Debt is not well covered by operating cash flow.
Dividends are not covered by earnings.
Annual revenue is forecast to grow slower than the American market.
Looking Ahead:
Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For International Business Machines, we've compiled three essential items you should further research:
Risks: We feel that you should assess the 4 warning signs for International Business Machines (1 is concerning!) we've flagged before making an investment in the company.
Future Earnings: How does IBM'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.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
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