A look at the intrinsic value of Abbott India Limited (NSE: ABBOTINDIA)
Does the December share price for Abbott India Limited (NSE: ABBOTINDIA) reflect its true value? Today, we’re going to estimate the intrinsic value of the stock by estimating the company’s future cash flows and discounting them to their present value. One way to do this is to use the Discounted Cash Flow (DCF) model. Believe it or not, it’s not too hard to follow, as you will see in our example!
There are many ways that businesses can be assessed, so we would like to point out that a DCF is not perfect for all situations. Anyone interested in learning a bit more about intrinsic value should read the Simply Wall St.
See our latest analysis for Abbott India
We are going to use a two-step DCF model, which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “steady growth”. First, we need to estimate the cash flow of the business over the next ten years. Since no free cash flow analyst estimate is available, we have extrapolated the previous free cash flow (FCF) from the last reported value of the company. 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.
In general, we assume that a dollar today is worth more than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today’s dollars:
10-year Free Cash Flow (FCF) estimate
|Leverage FCF (â¹, Millions)||11.9b||â¹ 14.7b||â¹ 17.4b||â¹ 19.9b||â¹ 22.4b||24.8b||â¹ 27.2b||â¹ 29.5b||â¹ 31.9b||â¹ 34.4b|
|Source of estimated growth rate||Is 30.27%||East @ 23.21%||East @ 18.27%||Est @ 14.81%||Est @ 12.39%||Is 10.69%||East @ 9.51%||Est @ 8.68%||Est @ 8.1%||Est @ 7.69%|
|Present value (â¹, millions) discounted at 12%||10.7k||11.8k||12.5k||â¹ 12.8k||â¹ 12.9k||â¹ 12.8k||12.5k||â¹ 12.2k||11.8k||11.3k|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 121b
We now need to calculate the Terminal Value, which takes into account all future cash flows after this ten year period. 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 (6.7%) to estimate future growth. Similar to the 10-year âgrowthâ period, we discount future cash flows to their present value, using a cost of equity of 12%.
Terminal value (TV)= FCF2031 Ã (1 + g) Ã· (r – g) = â¹ 34b Ã (1 + 6.7%) Ã· (12% – 6.7%) = â¹ 736b
Present value of terminal value (PVTV)= TV / (1 + r)ten= â¹ 736b Ã· (1 + 12%)ten= â¹ 243b
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is â¹ 364b. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of 19,000, the company appears to be around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
We draw your attention to the fact that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. 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 full picture of a company’s potential performance. Since we view Abbott India 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 debt into account. In this calculation, we used 12%, which is based on a leverage beta of 0.800. 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 of comparable companies globally, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.
While important, calculating DCF shouldn’t be the only metric you look at when looking for a business. It is not possible to achieve a rock-solid valuation with a DCF model. 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 Abbott India, we have put together three fundamental things to consider:
- Financial health: Does ABBOTINDIA 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.
- Other high quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get a feel for what you might be missing!
- Other picks from top analysts: Interested in seeing what analysts think? Take a look at our interactive list of analysts’ top stock picks to find out what they think might have a compelling outlook for the future!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each NSEI share. If you want to find the calculation for other actions, just search here.
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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 any stock 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 any of the stocks mentioned.