U.S. markets close in 3 hours 13 minutes
  • S&P 500

    4,010.54
    -61.16 (-1.50%)
     
  • Dow 30

    34,034.72
    -395.16 (-1.15%)
     
  • Nasdaq

    11,275.97
    -185.53 (-1.62%)
     
  • Russell 2000

    1,848.63
    -44.21 (-2.34%)
     
  • Crude Oil

    78.52
    -1.46 (-1.83%)
     
  • Gold

    1,782.30
    -27.30 (-1.51%)
     
  • Silver

    22.39
    -0.86 (-3.70%)
     
  • EUR/USD

    1.0500
    -0.0031 (-0.29%)
     
  • 10-Yr Bond

    3.5850
    +0.0790 (+2.25%)
     
  • GBP/USD

    1.2184
    -0.0113 (-0.91%)
     
  • USD/JPY

    136.6260
    +2.3550 (+1.75%)
     
  • BTC-USD

    17,086.53
    +75.61 (+0.44%)
     
  • CMC Crypto 200

    403.78
    -7.44 (-1.81%)
     
  • FTSE 100

    7,567.54
    +11.31 (+0.15%)
     
  • Nikkei 225

    27,820.40
    +42.50 (+0.15%)
     

Calculating The Fair Value Of American Electric Power Company, Inc. (NASDAQ:AEP)

How far off is American Electric Power Company, Inc. (NASDAQ:AEP) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Don't get put off by the jargon, the math behind it is actually quite straightforward.

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 want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

See our latest analysis for American Electric Power Company

The method

As American Electric Power Company operates in the electric utilities sector, we need to calculate the intrinsic value slightly differently. In this approach dividends per share (DPS) are used, as free cash flow is difficult to estimate and often not reported by analysts. Unless a company pays out the majority of its FCF as a dividend, this method will typically underestimate the value of the stock. The 'Gordon Growth Model' is used, which simply assumes that dividend payments will continue to increase at a sustainable growth rate forever. For a number of reasons a very conservative growth rate is used that cannot exceed that of a company's Gross Domestic Product (GDP). In this case we used the 5-year average of the 10-year government bond yield (1.9%). The expected dividend per share is then discounted to today's value at a cost of equity of 5.3%. Relative to the current share price of US$102, 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.

Value Per Share = Expected Dividend Per Share / (Discount Rate - Perpetual Growth Rate)

= US$3.4 / (5.3% – 1.9%)

= US$101

dcf
dcf

Important assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 American Electric Power 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 5.3%, which is based on a levered beta of 0.800. 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.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. 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 American Electric Power Company, we've put together three further aspects you should further examine:

  1. Risks: Take risks, for example - American Electric Power Company has 3 warning signs (and 1 which is a bit unpleasant) we think you should know about.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for AEP's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

  3. 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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.