Calculation of the fair value of Pfizer Limited (NSE: PFIZER)
In this article, we will estimate the intrinsic value of Pfizer Limited (NSE: PFIZER) by estimating the company’s future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don’t be put off by the jargon, the underlying calculations are actually quite simple.
Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. Anyone interested in learning a little more about intrinsic value should read the Simply Wall St.
Check out our latest analysis for Pfizer
Step by step in the calculation
We will use a two-stage 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 “sustained growth”. To start, we need to estimate the cash flows for the next ten years. Since no analyst estimate of free cash flow is available, we have extrapolated the previous free cash flow (FCF) from the company’s latest reported 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 more in early years than in later years.
Generally, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of present value:
Estimated free cash flow (FCF) over 10 years
|Leveraged FCF (₹, million)||₹7.95b||₹8.70b||₹9.45 billion||₹10.2 billion||₹11.0 billion||₹11.8 billion||₹12.7 billion||₹13.5 billion||₹14.5 billion||₹15.5 billion|
|Growth rate estimate Source||Is at 10.57%||Is at 9.42%||Is at 8.62%||Is at 8.05%||Is at 7.66%||Is at 7.38%||Is at 7.19%||Is at 7.06%||Is at 6.96%||Is at 6.89%|
|Present value (₹, million) discounted at 12%||₹7,100||₹7,000||₹6.8k||₹6,600||₹6,300||₹6,100||₹5.8k||₹5.6k||₹5.3k||₹5,100|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) =₹62b
We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. For a number of reasons, a very conservative growth rate is used which 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 “growth” period, we discount future cash flows to present value, using a cost of equity of 12%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = ₹15b × (1 + 6.7%) ÷ (12%–6.7%) = ₹332b
Present value of terminal value (PVTV)= TV / (1 + r)ten= ₹332b÷ (1 + 12%)ten= ₹109b
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is ₹171 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of ₹4.4k, the company appears around fair value at the time of writing. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep that in mind.
The above calculation is highly dependent on two assumptions. One is the discount rate and the other is the cash flows. You don’t have to agree with these entries, I recommend that you redo the calculations yourself and play around with them. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we view Pfizer 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 factors in debt. In this calculation, we used 12%, which is based on a leveraged beta of 0.800. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, 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 to consider when researching a business. DCF models are not the be-all and end-all 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 significantly change the overall result. For Pfizer, we’ve put together three relevant factors you should explore:
- Risks: Take risks, for example – Pfizer has 1 warning sign we think you should know.
- Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!
- Other environmentally friendly businesses: Are you concerned about the environment and do you think that consumers will buy more and more environmentally friendly products? Browse our interactive list of companies thinking about a greener future to discover actions you might not have thought of!
PS. Simply Wall St updates its DCF calculation for every Indian stock every day, so if you want to find the intrinsic value of any other stock, 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 only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.