Yahoo Finance A Look At The Fair Value Of Merck & Co., Inc. (NYSE:MRK)
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Today I will be providing a simple run through of a valuation method used to estimate the attractiveness of Merck & Co., Inc. (NYSE:MRK) as an investment opportunity by taking the foreast future cash flows of the company and discounting them back to today’s value. This is done using the Discounted Cash Flows (DCF) model. It may sound complicated, but actually it is quite simple! 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. If you are reading this and its not February 2019 then I highly recommend you check out the latest calculation for Merck by following the link below.
Check out our latest analysis for Merck
The calculation
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. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
5-year cash flow forecast
2019 | 2020 | 2021 | 2022 | 2023 | |
Levered FCF ($, Millions) | $11.39k | $12.40k | $13.94k | $13.48k | $13.76k |
Source | Analyst x3 | Analyst x5 | Analyst x4 | Analyst x2 | Analyst x2 |
Present Value Discounted @ 8.55% | $10.50k | $10.52k | $10.90k | $9.71k | $9.13k |
Present Value of 5-year Cash Flow (PVCF)= US$51b
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. For a number of reasons a very conservative growth rate is used that cannot exceed that of the GDP. In this case I have used the 10-year government bond rate (2.7%). In the same way as with the 5-year ‘growth’ period, we discount this to today’s value at a cost of equity of 8.5%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = US$14b × (1 + 2.7%) ÷ (8.5% – 2.7%) = US$243b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$243b ÷ ( 1 + 8.5%)5 = US$161b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$212b. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value of $81.52. Compared to the current share price of $79.81, the stock is about right, perhaps slightly undervalued at a 2.1% discount to what it is available for right now.
The 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 my inputs, I recommend redoing the calculations yourself and playing with them. Because we are looking at Merck 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 8.5%, which is based on a levered beta of 0.800. 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 MRK, I’ve put together three pertinent aspects you should look at:
Financial Health: Does MRK 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.
Future Earnings: How does MRK’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: Are there other high quality stocks you could be holding instead of MRK? 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 NYSE every 6 hours. If you want to find the calculation for other stocks just search here.
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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. On rare occasion, data errors may occur. Thank you for reading.
