Advertisement
U.S. markets open in 6 hours 19 minutes
  • S&P Futures

    5,207.75
    -7.00 (-0.13%)
     
  • Dow Futures

    39,218.00
    -5.00 (-0.01%)
     
  • Nasdaq Futures

    18,174.50
    -57.00 (-0.31%)
     
  • Russell 2000 Futures

    2,047.80
    -2.00 (-0.10%)
     
  • Crude Oil

    82.57
    -0.15 (-0.18%)
     
  • Gold

    2,158.70
    -5.60 (-0.26%)
     
  • Silver

    25.11
    -0.15 (-0.59%)
     
  • EUR/USD

    1.0865
    -0.0012 (-0.11%)
     
  • 10-Yr Bond

    4.3400
    0.0000 (0.00%)
     
  • Vix

    14.33
    0.00 (0.00%)
     
  • GBP/USD

    1.2701
    -0.0028 (-0.22%)
     
  • USD/JPY

    150.2970
    +1.1990 (+0.80%)
     
  • Bitcoin USD

    64,110.11
    -4,251.32 (-6.22%)
     
  • CMC Crypto 200

    885.54
    0.00 (0.00%)
     
  • FTSE 100

    7,722.55
    -4.87 (-0.06%)
     
  • Nikkei 225

    40,003.60
    +263.20 (+0.66%)
     

HP Inc. (NYSE:HPQ) Shares Could Be 39% Below Their Intrinsic Value Estimate

Today we will run through one way of estimating the intrinsic value of HP Inc. (NYSE:HPQ) by taking the forecast future cash flows of the company and discounting them back to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for HP

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$4.47b

US$4.29b

US$3.12b

US$3.02b

US$2.98b

US$2.96b

US$2.97b

US$3.00b

US$3.03b

US$3.07b

Growth Rate Estimate Source

Analyst x5

Analyst x3

Analyst x1

Analyst x1

Est @ -1.5%

Est @ -0.46%

Est @ 0.27%

Est @ 0.79%

Est @ 1.14%

Est @ 1.39%

Present Value ($, Millions) Discounted @ 8.7%

US$4.1k

US$3.6k

US$2.4k

US$2.2k

US$2.0k

US$1.8k

US$1.7k

US$1.5k

US$1.4k

US$1.3k

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

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 (2.0%) 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 8.7%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$3.1b× (1 + 2.0%) ÷ (8.7%– 2.0%) = US$47b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$47b÷ ( 1 + 8.7%)10= US$20b

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$42b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$25.7, the company appears quite good value at a 39% 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
dcf

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 HP 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 8.7%, which is based on a levered beta of 1.433. 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.

Moving On:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Can we work out why the company is trading at a discount to intrinsic value? For HP, we've compiled three relevant elements you should assess:

  1. Risks: We feel that you should assess the 5 warning signs for HP (2 shouldn't be ignored!) we've flagged before making an investment in the company.

  2. Future Earnings: How does HPQ'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: 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.

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.

Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here

Advertisement