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Calculating The Fair Value Of Boston Scientific Corporation (NYSE:BSX)

Simply Wall St

Does the December share price for Boston Scientific Corporation (NYSE:BSX) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by estimating the company's future cash flows and discounting them to their present value. I will use the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

See our latest analysis for Boston Scientific

The model

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To begin with, we have to get estimates of 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2020 2021 2022 2023 2024 2025 2026 2027 2028 2029
Levered FCF ($, Millions) US$2.28b US$2.58b US$3.21b US$3.32b US$3.41b US$3.49b US$3.57b US$3.64b US$3.71b US$3.78b
Growth Rate Estimate Source Analyst x4 Analyst x4 Analyst x1 Analyst x1 Est @ 2.67% Est @ 2.39% Est @ 2.2% Est @ 2.06% Est @ 1.96% Est @ 1.9%
Present Value ($, Millions) Discounted @ 7.1% US$2.1k US$2.3k US$2.6k US$2.5k US$2.4k US$2.3k US$2.2k US$2.1k US$2.0k US$1.9k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$22b

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 10-year government bond rate (1.7%) 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 7.1%.

Terminal Value (TV)= FCF2029 × (1 + g) ÷ (r – g) = US$3.8b× (1 + 1.7%) ÷ 7.1%– 1.7%) = US$72b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$72b÷ ( 1 + 7.1%)10= US$36b

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$59b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$43.3, 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.

NYSE:BSX Intrinsic value, December 5th 2019

Important assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the 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 Boston Scientific 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 7.1%, which is based on a levered beta of 0.980. 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:

Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. For Boston Scientific, There are three additional aspects you should look at:

  1. Financial Health: Does BSX have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Future Earnings: How does BSX's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  3. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of BSX? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

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

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

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