Using the 2 Stage Free Cash Flow to Equity, Public Service Enterprise Group fair value estimate is US$62.40
Public Service Enterprise Group's US$83.19 share price signals that it might be 33% overvalued
Analyst price target for PEG is US$89.06, which is 43% above our fair value estimate
How far off is Public Service Enterprise Group Incorporated (NYSE:PEG) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
The Model
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) estimate
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF ($, Millions)
-US$112.7m
US$66.3m
US$264.0m
US$493.0m
US$688.6m
US$885.2m
US$1.07b
US$1.23b
US$1.37b
US$1.50b
Growth Rate Estimate Source
Analyst x2
Analyst x2
Analyst x1
Analyst x1
Est @ 39.67%
Est @ 28.55%
Est @ 20.77%
Est @ 15.33%
Est @ 11.52%
Est @ 8.85%
Present Value ($, Millions) Discounted @ 5.9%
-US$106
US$59.1
US$222
US$392
US$517
US$627
US$715
US$778
US$820
US$842
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = US$4.9b
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. 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 have used the 5-year average of the 10-year government bond yield (2.6%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 5.9%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$47b÷ ( 1 + 5.9%)10= US$26b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$31b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Relative to the current share price of US$83.2, the company appears potentially overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
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. 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 Public Service Enterprise 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 5.9%, which is based on a levered beta of 0.800. 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 Public Service Enterprise Group
Strength
Debt is well covered by earnings.
Balance sheet summary for PEG.
Weakness
Earnings declined over the past year.
Dividend is low compared to the top 25% of dividend payers in the Integrated Utilities market.
Expensive based on P/E ratio and estimated fair value.
Opportunity
Annual earnings are forecast to grow for the next 3 years.
Threat
Debt is not well covered by operating cash flow.
Paying a dividend but company has no free cash flows.
Annual earnings are forecast to grow slower than the American market.
Is PEG well equipped to handle threats?
Moving On:
Although the valuation of a company is important, 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. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a premium to intrinsic value? For Public Service Enterprise Group, there are three important aspects you should consider:
Risks: To that end, you should learn about the 3 warning signs we've spotted with Public Service Enterprise Group (including 1 which is concerning) .
Future Earnings: How does PEG'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.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
我们要指出,折现现金流最重要的输入是折现率和实际现金流。你不必同意这些输入,我建议你自己重新计算并进行调整。DCF还没有考虑到行业的周期性,或者公司的未来资本需求,因此并不能全面反映公司的潜在表现。考虑到我们将公务集团视为潜在股东,股本成本被用作折现率,而不是资本成本(或加权平均资本成本,WACC),后者考虑了债务。在这个计算中,我们使用了5.9%,这是基于0.800的杠杆贝塔。贝塔是比较股票与整个市场波动性的度量。我们的贝塔来自全球可比公司的行业平均贝塔,并 imposed a limit between 0.8 and 2.0, a reasonable 区间 for a stable 业务.