Is There An Opportunity With Shire plc’s (LON:SHP) 26% Undervaluation?
I am going to run you through how I calculated the intrinsic value of Shire plc (LSE:SHP) using the discounted cash flow (DCF) method. 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 Shire here.
What’s the value?
I use what is known as the 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the initial phase has higher growth rates that plateau over time. To begin, I use the analyst consensus forecast of SHP’s levered free cash flow (FCF) over the next five years and discounted these figures at the cost of equity of 8.97%. This resulted in a present value of 5-year cash flow of US$19.40B. Keen to know how I arrived at this number? Check out our detailed analysis here.
In the visual above, we see how how SHP’s earnings are expected to move going forward, which should give you an idea of SHP’s outlook. Now we need to determine the terminal value, which accounts for all the future cash flows after the five years. I’ve decided to use the 10-year government bond rate of 2.8% as the perpetual 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$48.16B.
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$67.56B. The last step is to then divide the equity value by the number of shares outstanding. This results in an intrinsic value of £55.03, which, compared to the current share price of £40.625, we find that Shire is about right, perhaps slightly undervalued at a 26.18% discount to what it is available for right now.
Next Steps:
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. What is the reason for the share price to differ from the intrinsic value? For SHP, there are three essential factors you should further research:
Financial Health: Does SHP 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 SHP’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 SHP? 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 GB 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.
