Calculating The Fair Value Of The Aaron's Company, Inc. (NYSE:AAN)
Key Insights
Using the 2 Stage Free Cash Flow to Equity, Aaron's Company fair value estimate is US$8.91
Current share price of US$10.24 suggests Aaron's Company is potentially trading close to its fair value
The US$11.80 analyst price target for AAN is 32% more than our estimate of fair value
In this article we are going to estimate the intrinsic value of The Aaron's Company, Inc. (NYSE:AAN) by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
Check out our latest analysis for Aaron's Company
The Method
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$30.9m | US$23.8m | US$22.3m | US$30.8m | US$30.9m | US$31.1m | US$31.5m | US$32.0m | US$32.5m | US$33.1m |
Growth Rate Estimate Source | Analyst x1 | Analyst x1 | Analyst x1 | Analyst x1 | Est @ 0.17% | Est @ 0.79% | Est @ 1.22% | Est @ 1.52% | Est @ 1.73% | Est @ 1.88% |
Present Value ($, Millions) Discounted @ 12% | US$27.6 | US$18.9 | US$15.7 | US$19.4 | US$17.3 | US$15.6 | US$14.1 | US$12.7 | US$11.5 | US$10.5 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$163m
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. 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 have used the 5-year average of the 10-year government bond yield (2.2%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 12%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$33m× (1 + 2.2%) ÷ (12%– 2.2%) = US$339m
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$339m÷ ( 1 + 12%)10= US$107m
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$270m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$10.2, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
The Assumptions
Now 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 evaluation of a company's future performance, so try the calculation yourself and check your own 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 Aaron's Company 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 12%, which is based on a levered beta of 2.000. 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 Aaron's Company
Strength
Debt is not viewed as a risk.
Dividend is in the top 25% of dividend payers in the market.
Weakness
Earnings declined over the past year.
Expensive based on P/E ratio and estimated fair value.
Opportunity
Annual earnings are forecast to grow faster than the American market.
Significant insider buying over the past 3 months.
Threat
Dividends are not covered by earnings.
Annual revenue is forecast to grow slower than the American market.
Looking Ahead:
Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Aaron's Company, we've compiled three fundamental aspects you should look at:
Risks: Take risks, for example - Aaron's Company has 3 warning signs we think you should be aware of.
Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for AAN's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
Other Solid Businesses: 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 business fundamentals to see if there are other companies you may not have considered!
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.
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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.
