Today we are going to review a valuation method used to estimate the attractiveness of Haverty Furniture Companies, Inc. (NYSE: HVT) as an investment opportunity by taking forecasts of future cash flows from company and updating them against today’s forecasts. value. To this end, we will take advantage of the Discounted Cash Flow (DCF) model. Patterns like these may seem beyond a layman’s comprehension, but they are fairly easy to follow.
Remember, however, that there are many ways to estimate the value of a business, and a DCF is just one method. Anyone who wants to learn a little more about intrinsic value should read the Simply Wall St.
Are Haverty furniture companies properly valued?
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually the first stage is higher growth and the second stage is lower growth stage. In the first step, we need to estimate the cash flow of the business over the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF ($, Millions)||US $ 60.5 million||US $ 56.5 million||US $ 54.2 million||US $ 52.9 million||US $ 52.4 million||US $ 52.4 million||US $ 52.7 million||US $ 53.2 million||US $ 53.8 million||US $ 54.6 million|
|Source of estimated growth rate||Analyst x1||Is @ -6.67%||Is @ -4.07%||East @ -2.25%||East @ -0.98%||East @ -0.09%||Is @ 0.53%||Est @ 0.97%||Is @ 1.28%||Est @ 1.49%|
|Present value (in millions of dollars) discounted at 9.0%||US $ 55.5||US $ 47.6||US $ 41.9||US $ 37.6||US $ 34.1||$ 31.3||$ 28.9||$ 26.8||US $ 24.9||$ 23.2|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 351 million US dollars
After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. 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 used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 9.0%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US $ 55 million × (1 + 2.0%) ÷ (9.0% to 2.0%) = US $ 799 million
Present value of terminal value (PVTV)= TV / (1 + r)ten= US $ 799 million ÷ (1 + 9.0%)ten= 339 million US dollars
The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $ 690 million. The last step is then to divide the equity value by the number of shares outstanding. From the current share price of US $ 35.2, the company appears to be roughly at fair value with a 6.5% discount to the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
NYSE: HVT Discounted Cash Flow August 22, 2021
Now the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Because we view Haverty Furniture Companies 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 takes into account debt. In this calculation, we used 9.0%, which is based on a leveraged beta of 1.478. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average beta from globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
While important, calculating DCF ideally won’t be the only piece of analysis you’ll look at for a business. DCF models are not the alpha and omega of investment valuation. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For Haverty Furniture Companies, we have put together three fundamental aspects that you should explore:
- Risks: Take risks, for example – Haverty Furniture Companies has 3 warning signs (and 1 which is potentially serious) we think you should be aware of.
- Future benefits: How does HVT’s growth rate compare to its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
- Other strong companies: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you might not have considered!
PS. Simply Wall St updates its DCF calculation for every US stock every day, so if you want to find the intrinsic value of any other stock just search here.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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