Today I will be providing a simple run-through of the discounted cash flows (DCF) method to estimate the attractiveness of Constellation Software Inc (TSX:CSU) as an investment opportunity. If you want to learn more about this method, the basis for my calculations can be found in detail in the Simply Wall St analysis model. Also note that this article was written in May 2018 so be sure check the latest calculation for Constellation Software here.
Crunching the numbers
I use what is known as the 2-stage model, which takes into account the initial higher growth stage of a company’s life cycle and the steadier growth phase over the long run. Firstly, I use the analyst consensus estimates of CSU’s levered free cash flow (FCF) over the next five years and discounted these values at the cost of equity of 8.43%. When estimates weren’t available, I’ve extrapolated the average annual growth rate over the previous five years, capped at a reasonable level. This resulted in a present value of 5-year cash flow of US$3.37B. Keen to know how I arrived at this number? Check out our detailed analysis here.
The graph above shows how CSU’s earnings are expected to move in the future, which should give you some color on CSU’s outlook. Secondly, I calculate the terminal value, which accounts for all the future cash flows after the five years. It’s appropriate to use the 10-year government bond rate of 2.8% as the steady growth rate, which is rightly below GDP growth, but more towards the conservative side. Discounting the terminal value back five years gives us a present value of US$12.46B.
The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is US$15.82B. To get the intrinsic value per share, we divide this by the total number of shares outstanding. This results in an intrinsic value of CA$956.80, which, compared to the current share price of CA$976.81, we find that Constellation Software is fair value, maybe slightly overvalued and not available at a discount at this time.
Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company.
For CSU, I’ve put together three key aspects you should further examine:
- Financial Health: Does CSU 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 CSU’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: Are there other high quality stocks you could be holding instead of CSU? 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 for every stock on the TSX every 6 hours. If you want to find the calculation for other stocks just search here.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.