Today I will be providing a simple run-through of the discounted cash flows (DCF) method to estimate the attractiveness of O’Reilly Automotive Inc (NASDAQ:ORLY) 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. If you are reading this after June 2018 then I highly recommend you check out the latest calculation for O’Reilly Automotive here.
What’s the value?
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 start off, I pulled together the analyst consensus forecast of ORLY’s levered free cash flow (FCF) over the next five years and discounted these figures at the rate of 9.15%. 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$5.11B. Want to understand how I calculated this value? Take a look at our detailed analysis here.
The infographic above illustrates how ORLY’s earnings are expected to move in the future, which should give you an idea of ORLY’s outlook. Then, I determine the terminal value, which is the business’s cash flow after the first stage. 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. The present value of the terminal value after discounting it back five years is US$16.43B.
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$21.54B. The last step is to then divide the equity value by the number of shares outstanding. This results in an intrinsic value of $262.93, which, compared to the current share price of $284.78, we find that O’Reilly Automotive is fair value, maybe slightly overvalued at the time of writing.
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn’t be the only metric you look at when researching a company.
For ORLY, I’ve compiled three pertinent factors you should further examine:
- Financial Health: Does ORLY 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 ORLY’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 ORLY? 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 does a DCF calculation for every US stock every 6 hours, so if you want to find the intrinsic value of any other stock 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.