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Is UnitedHealth Group Incorporated (NYSE:UNH) Trading At A 36% Discount?

Today we will run through one way of estimating the intrinsic value of UnitedHealth Group Incorporated (NYSE:UNH) by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for UnitedHealth Group

The method

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. 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.

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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) forecast

2022

2023

2024

2025

2026

2027

2028

2029

2030

2031

Levered FCF ($, Millions)

US$20.6b

US$23.8b

US$28.9b

US$31.7b

US$30.4b

US$29.8b

US$29.5b

US$29.5b

US$29.6b

US$29.9b

Growth Rate Estimate Source

Analyst x5

Analyst x4

Analyst x3

Analyst x2

Analyst x1

Est @ -2.1%

Est @ -0.89%

Est @ -0.05%

Est @ 0.54%

Est @ 0.96%

Present Value ($, Millions) Discounted @ 5.5%

US$19.5k

US$21.4k

US$24.6k

US$25.6k

US$23.2k

US$21.6k

US$20.3k

US$19.2k

US$18.3k

US$17.5k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$211b

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. 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 1.9%. We discount the terminal cash flows to today's value at a cost of equity of 5.5%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$30b× (1 + 1.9%) ÷ (5.5%– 1.9%) = US$848b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$848b÷ ( 1 + 5.5%)10= US$495b

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$706b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$486, the company appears quite good value at a 36% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
dcf

Important assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 UnitedHealth Group 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 5.5%, which is based on a levered beta of 0.849. 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.

Looking Ahead:

Whilst important, the DCF calculation ideally won't be the sole piece of analysis you scrutinize for a company. It's not possible to obtain a foolproof valuation with a DCF model. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For UnitedHealth Group, we've compiled three pertinent aspects you should assess:

  1. Risks: To that end, you should be aware of the 1 warning sign we've spotted with UnitedHealth Group .

  2. Future Earnings: How does UNH'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.

  3. 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.