The projected fair value for Watts Water Technologies is US$218 based on 2 Stage Free Cash Flow to Equity
Current share price of US$187 suggests Watts Water Technologies is potentially trading close to its fair value
The US$206 analyst price target for WTS is 5.4% less than our estimate of fair value
In this article we are going to estimate the intrinsic value of Watts Water Technologies, Inc. (NYSE:WTS) by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
What's The Estimated Valuation?
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
Levered FCF ($, Millions)
US$279.6m
US$306.7m
US$328.8m
US$351.8m
US$369.6m
US$385.4m
US$399.6m
US$412.8m
US$425.3m
US$437.4m
Growth Rate Estimate Source
Analyst x3
Analyst x3
Analyst x1
Analyst x1
Est @ 5.07%
Est @ 4.26%
Est @ 3.70%
Est @ 3.30%
Est @ 3.03%
Est @ 2.83%
Present Value ($, Millions) Discounted @ 7.1%
US$261
US$267
US$268
US$267
US$262
US$255
US$247
US$238
US$229
US$220
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = US$2.5b
The second stage is also known as Terminal Value, this is the business's cash flow after 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 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 7.1%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$9.5b÷ ( 1 + 7.1%)10= US$4.8b
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$7.3b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$187, the company appears about fair value at a 14% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
NYSE:WTS Discounted Cash Flow June 11th 2024
The Assumptions
We would 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 these result, have a go at the calculation yourself and play with the assumptions. 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 Watts Water Technologies 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 7.1%, which is based on a levered beta of 1.030. 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 Watts Water Technologies
Strength
Debt is not viewed as a risk.
Dividends are covered by earnings and cash flows.
Dividend information for WTS.
Weakness
Earnings growth over the past year underperformed the Machinery industry.
Dividend is low compared to the top 25% of dividend payers in the Machinery market.
Opportunity
Annual earnings are forecast to grow for the next 3 years.
Current share price is below our estimate of fair value.
Threat
Annual earnings are forecast to grow slower than the American market.
What else are analysts forecasting for WTS?
Next Steps:
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess 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. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Watts Water Technologies, there are three essential items you should further research:
Risks: You should be aware of the 1 warning sign for Watts Water Technologies we've uncovered before considering an investment in the company.
Future Earnings: How does WTS'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks 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.
我们要指出的是,贴现现金流的最重要投入是贴现率,当然还有实际的现金流。如果你不同意这些结果,那就自己计算一下,试一试假设。DCF也没有考虑一个行业可能的周期性,也没有考虑公司未来的资本需求,因此它没有全面反映公司的潜在表现。鉴于我们将Watts Water Technologies视为潜在股东,因此使用股本成本作为贴现率,而不是构成债务的资本成本(或加权平均资本成本,WACC)。在此计算中,我们使用了7.1%,这是基于1.030的杠杆测试版。Beta是衡量股票与整个市场相比波动性的指标。我们的测试版来自全球可比公司的行业平均贝塔值,设定在0.8到2.0之间,这是一个稳定的业务的合理范围。