Yahoo Finance Smiths Group plc (LON:SMIN) Investors Are Paying Above The Intrinsic Value
I am going to run you through how I calculated the intrinsic value of Smiths Group plc (LON:SMIN) by estimating the company’s future cash flows and discounting them to their present value. I will be using the Discounted Cash Flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. If you are reading this and its not June 2018 then I highly recommend you check out the latest calculation for Smiths Group by following the link below. View out our latest analysis for Smiths Group
Is SMIN fairly valued?
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. The sum of these cash flows is then discounted to today’s value.
5-year cash flow estimate
2018 | 2019 | 2020 | 2021 | 2022 | |
Levered FCF (£, Millions) | £376.97 | £383.39 | £398.07 | £402.07 | £406.12 |
Source | Analyst x7 | Analyst x9 | Analyst x6 | Extrapolated @ (1.01%) | Extrapolated @ (1.01%) |
Present Value Discounted @ 9.28% | £344.95 | £321.02 | £304.99 | £281.89 | £260.54 |
Present Value of 5-year Cash Flow (PVCF)= UK£1.51b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after the five years. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 1.4%. We discount this to today’s value at a cost of equity of 9.3%.
Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = UK£406.12m × (1 + 1.4%) ÷ (9.3% – 1.4%) = UK£5.22b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = UK£5.22b ÷ ( 1 + 9.3%)5 = UK£3.35b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is UK£4.86b. 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 £12.29. Compared to the current share price of £17.62, the stock is rather overvalued at the time of writing.
Important assumptions
I’d like to point out that 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 Smiths 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 9.3%, which is based on a levered beta of 0.917. 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:
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. What is the reason for the share price to differ from the intrinsic value? For SMIN, there are three relevant factors you should further examine:
Financial Health: Does SMIN 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 SMIN’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 SMIN? 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 does a DCF calculation for every GB stock every 6 hours, so if you want to find the intrinsic value of any other stock just search here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
