Today we are going to review a valuation method used to estimate the attractiveness of Ralph Lauren Corporation (NYSE: RL) as an investment opportunity by taking the company’s future cash flow forecast. and updating them to today’s value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but it’s actually quite simple!
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 knowing a little more about intrinsic value should read the Simply Wall St analysis model.
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Is Ralph Lauren valued enough?
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”. To begin with, we need to get cash flow estimates for the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated 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 down more in the early years than in subsequent years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, so we discount the value of those future cash flows to their estimated value in today’s dollars. hui:
10-year free cash flow (FCF) forecast
|Leverage FCF ($, Millions)||US $ 565.5 million||US $ 657.8 million||US $ 657.7 million||US $ 726.5 million||US $ 744.5 million||US $ 760.6 million||US $ 776.6 million||US $ 792.6 million||US $ 808.7 million||US $ 825.0 million|
|Source of estimated growth rate||Analyst x8||Analyst x8||Analyst x6||Analyst x2||Analyst x2||Is @ 2.17%||East @ 2.1%||East @ 2.06%||East @ 2.03%||East @ 2.01%|
|Present value (in millions of dollars) discounted at 7.5%||US $ 526||US $ 569||US $ 529||$ 544||$ 518||US $ 493||US $ 468||$ 444||$ 422||US $ 400|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 4.9 billion US dollars
The second stage is also known as terminal value, it is the cash flow of the business after the first stage. 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 (2.0%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 7.5%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US $ 825 million × (1 + 2.0%) ÷ (7.5% to 2.0%) = US $ 15 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= US $ 15 billion ÷ (1 + 7.5%)ten= US $ 7.4 billion
The total value is the sum of the cash flows for the next ten years plus the final present value, which gives the total value of equity, which in this case is US $ 12 billion. The last step is then to divide the equity value by the number of shares outstanding. From the current share price of US $ 119, the company appears to be slightly undervalued at a 29% discount from the current share price. Ratings are imprecise instruments, however, much like a telescope – move a few degrees and end up in another galaxy. Keep this in mind.
The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. 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 Ralph Lauren 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 into account debt. In this calculation, we used 7.5%, which is based on a leveraged beta of 1.267. 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.
Valuation is only one side of the coin in terms of building your investment thesis, and it’s just one of the many factors you need to evaluate for a business. It is not possible to achieve a rock-solid valuation with a DCF model. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. Why is intrinsic value greater than the current share price? For Ralph Lauren, we’ve compiled three more aspects that you need to evaluate:
- Risks: Concrete example, we have spotted 1 warning sign for Ralph Lauren you must be aware.
- Future benefits: How does RL’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus number for years to come by interacting with our free analyst growth expectations chart.
- Other strong companies: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for every NYSE 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.