Calculating The Intrinsic Value Of Vector Group Ltd. (NYSE:VGR)

Key Insights

• Vector Group's estimated fair value is US$11.53 based on 2 Stage Free Cash Flow to Equity

• Vector Group's US$11.25 share price indicates it is trading at similar levels as its fair value estimate

• Industry average discount to fair value of 39% suggests Vector Group's peers are currently trading at a higher discount

Does the August share price for Vector Group Ltd. (NYSE:VGR) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

See our latest analysis for Vector Group

What's The Estimated Valuation?

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 begin with, we have to get estimates of the next ten years of cash flows. Seeing as no analyst estimates of free cash flow are available to us, we have extrapolate the previous free cash flow (FCF) from the company's last 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, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$139.1m	US$122.2m	US$112.6m	US$107.1m	US$104.2m	US$102.8m	US$102.6m	US$103.1m	US$104.1m	US$105.4m
Growth Rate Estimate Source	Est @ -18.28%	Est @ -12.15%	Est @ -7.86%	Est @ -4.86%	Est @ -2.75%	Est @ -1.28%	Est @ -0.25%	Est @ 0.47%	Est @ 0.97%	Est @ 1.33%
Present Value ($, Millions) Discounted @ 7.3%	US$130	US$106	US$91.0	US$80.7	US$73.1	US$67.2	US$62.5	US$58.5	US$55.0	US$51.9

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$776m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond 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 7.3%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$105m× (1 + 2.2%) ÷ (7.3%– 2.2%) = US$2.1b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$2.1b÷ ( 1 + 7.3%)¹⁰= US$1.0b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$1.8b. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$11.3, the company appears about fair value at a 2.4% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

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. 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 Vector Group 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 7.3%, which is based on a levered beta of 1.038. 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 Vector Group

Strength

• Earnings growth over the past year exceeded the industry.

• Debt is well covered by earnings.

• Dividends are covered by earnings and cash flows.

• Dividend is in the top 25% of dividend payers in the market.

Weakness

• No major weaknesses identified for VGR.

Opportunity

• Annual revenue is forecast to grow faster than the American market.

• Current share price is below our estimate of fair value.

Threat

• Debt is not well covered by operating cash flow.

• Total liabilities exceed total assets, which raises the risk of financial distress.

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching 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 Vector Group, we've compiled three fundamental items you should further examine:

1. Risks: Take risks, for example - Vector Group has 4 warning signs (and 2 which are a bit concerning) we think you should know about.

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

3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

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.