Edwards Lifesciences Corporation's (NYSE:EW) Intrinsic Value Is Potentially 17% Below Its Share Price
Key Insights
Using the 2 Stage Free Cash Flow to Equity, Edwards Lifesciences fair value estimate is US$76.80
Edwards Lifesciences is estimated to be 21% overvalued based on current share price of US$92.85
Our fair value estimate is 16% lower than Edwards Lifesciences' analyst price target of US$91.83
How far off is Edwards Lifesciences Corporation (NYSE:EW) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
View our latest analysis for Edwards Lifesciences
Crunching The Numbers
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$1.36b | US$1.65b | US$1.77b | US$1.85b | US$2.04b | US$2.15b | US$2.25b | US$2.33b | US$2.41b | US$2.49b |
Growth Rate Estimate Source | Analyst x6 | Analyst x5 | Analyst x4 | Analyst x2 | Analyst x2 | Est @ 5.49% | Est @ 4.53% | Est @ 3.86% | Est @ 3.39% | Est @ 3.06% |
Present Value ($, Millions) Discounted @ 6.5% | US$1.3k | US$1.5k | US$1.5k | US$1.4k | US$1.5k | US$1.5k | US$1.4k | US$1.4k | US$1.4k | US$1.3k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$14b
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.3%. We discount the terminal cash flows to today's value at a cost of equity of 6.5%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$2.5b× (1 + 2.3%) ÷ (6.5%– 2.3%) = US$60b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$60b÷ ( 1 + 6.5%)10= US$32b
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$46b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$92.9, the company appears slightly overvalued at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.
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 Edwards Lifesciences 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 6.5%, which is based on a levered beta of 0.918. 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 Edwards Lifesciences
Strength
Debt is not viewed as a risk.
Weakness
Earnings declined over the past year.
Expensive based on P/E ratio and estimated fair value.
Opportunity
Annual revenue is forecast to grow faster than the American market.
Threat
Annual earnings are forecast to grow slower than the American market.
Looking Ahead:
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. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price exceeding the intrinsic value? For Edwards Lifesciences, there are three additional elements you should assess:
Financial Health: Does EW 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.
Future Earnings: How does EW'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.
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.
