In this analysis, we explore the estimation of the fair value of Deere & Company (NYSE: DE) using the Discounted Cash Flow (DCF) model. This financial tool projects future cash flows and discounts them to their present value, offering valuable insights into the stock’s potential intrinsic worth.
The Complexity of Valuation
Valuing companies can be approached in various ways, and it’s essential to recognize that a DCF model is not a one-size-fits-all solution. Additionally, different methods can be appropriate for different situations. For instance, investors looking to delve deeper into intrinsic value may want to explore alternative models that offer a broader perspective on valuation.
Understanding the DCF Model
The DCF model, as the name suggests, involves two stages of growth. The initial stage accounts for higher growth, which eventually levels off in the second ‘steady growth’ phase. In the first stage, projecting cash flows over the next ten years is crucial. Analyst estimates are ideal, but if not available, extrapolation from previous free cash flow (FCF) or reported values is used. This accounts for the fact that companies with decreasing free cash flow will likely slow down their rate of shrinkage, and those with growing free cash flow will experience a slower growth rate over this period.
Calculating the Terminal Value
The Terminal Value considers all future cash flows beyond the initial ten-year period. It is calculated using the Gordon Growth formula at a future annual growth rate equivalent to the 5-year average of the 10-year government bond yield, which stands at 2.2%. Terminal cash flows are then discounted to their present value at a cost of equity of 8.6%.
Evaluating the Results
The intrinsic value of Deere & Company is calculated as the sum of the present value of future cash flows, totaling approximately US$121 billion. When dividing this equity value by the number of shares outstanding, it indicates a valuation roughly 11% below the current stock price of US$375. However, it’s crucial to remember that this valuation is an approximation, and it relies on the quality of the input data, making precise inputs essential.
Considerations and Assumptions
Two primary inputs significantly impact the DCF calculation: the discount rate and the actual cash flows. It’s important to note that the DCF model does not account for industry cyclicality or a company’s future capital requirements. In this analysis, we use a discount rate of 8.6%, representing the cost of equity, and it reflects a levered beta of 1.295. Beta measures a stock’s volatility in comparison to the overall market. It’s important to note that we derive the beta from the industry’s average beta of globally comparable companies, which falls within a range set between 0.8 and 2.0—a range suitable for assessing a stable business.
Strengths, Weaknesses, Opportunities, and Threats
The analysis delves into SWOT factors, highlighting strengths and weaknesses in Deere & Company’s financial position and performance, along with potential opportunities and threats. Key points include earnings growth, debt coverage, dividends, and forecasted trends.
While the DCF model is a valuable tool for assessing a company’s intrinsic value, it’s crucial to recognize that it’s just one element in the broader assessment of a company’s investment potential. Factors such as risks, future earnings, and alternatives should be considered to gain a comprehensive understanding of the investment landscape.