Graham's estimated fair value is US$26.75 based on 2 Stage Free Cash Flow to Equity
With US$27.84 share price, Graham appears to be trading close to its estimated fair value
Peers of Graham are currently trading on average at a 24% discount
How far off is Graham Corporation (NYSE:GHM) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
The Model
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
Levered FCF ($, Millions)
US$18.1m
US$15.9m
US$14.7m
US$14.1m
US$13.7m
US$13.6m
US$13.6m
US$13.7m
US$13.9m
US$14.1m
Growth Rate Estimate Source
Analyst x1
Est @ -11.89%
Est @ -7.58%
Est @ -4.55%
Est @ -2.44%
Est @ -0.96%
Est @ 0.08%
Est @ 0.81%
Est @ 1.31%
Est @ 1.67%
Present Value ($, Millions) Discounted @ 6.6%
US$17.0
US$14.0
US$12.2
US$10.9
US$10.0
US$9.3
US$8.7
US$8.2
US$7.8
US$7.4
("Est" = FCF growth rate estimated by Simply Wall St) Present Value of 10-year Cash Flow (PVCF) = US$105m
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 2.5%. We discount the terminal cash flows to today's value at a cost of equity of 6.6%.
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$352m÷ ( 1 + 6.6%)10= US$185m
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$291m. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$27.8, the company appears around fair value at the time of writing. 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.
Important Assumptions
Now 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 Graham 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 6.6%, which is based on a levered beta of 0.999. 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 Graham
Strength
Earnings growth over the past year exceeded the industry.
Currently debt free.
Balance sheet summary for GHM.
Weakness
Expensive based on P/E ratio and estimated fair value.
What are analysts forecasting for GHM?
Opportunity
Annual earnings are forecast to grow faster than the American market.
Threat
No apparent threats visible for GHM.
Next Steps:
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching 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 Graham, we've compiled three pertinent aspects you should assess:
Financial Health: Does GHM 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 GHM'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.
主要見解
基於兩階段自由現金流向股權法,Graham的估計公允價值爲26.75美元。
以27.84美元/股的股價計算,Graham的交易價格似乎接近其估計的公允價值。
Graham同行業板塊目前平均折價24%。
Graham Corporation (紐交所:GHM)距離其內在價值有多遠?使用最近的財務數據,我們將通過將預期未來現金流貼現到今天的價值來審視財務股票是否定價合理。我們的分析將採用折現現金流(DCF)模型。無論你信不信,它都不難理解,你會從我們的示例中發現的!