Today I will be providing a simple run-through of the discounted cash flows (DCF) method to estimate the attractiveness of Parker-Hannifin Corporation (NYSE:PH) 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 January 2018 then I highly recommend you check out the latest calculation for Parker-Hannifin here.
Is PH fairly valued?
I’ve used the 2-stage growth 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. Firstly, I pulled together the analyst consensus estimates of PH’s levered free cash flow (FCF) over the next five years and discounted these values at the cost of equity of 9.81%. This resulted in a present value of 5-year cash flow of $6,412.6M. Keen to know how I arrived at this number? Take a look at our detailed analysis here.
Above is a visual representation of how PH’s earnings are expected to move in the future, which should give you some color on PH’s outlook. Now we need to determine 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 stable growth rate, which is rightly below GDP growth, but more towards the conservative side. After discounting the terminal value back five years, the present value becomes $16,538.0M.
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 $22,950.6M. The last step is to then divide the equity value by the number of shares outstanding. This results in an intrinsic value of $172.27, which, compared to the current share price of $210.94, we see that Parker-Hannifin is fair value, maybe slightly overvalued and not available at a discount at this time.
Although the valuation of a company is important, 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 PH, I’ve compiled three important factors you should further examine:
- 1. Financial Health: Does PH 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.
- 2. Future Earnings: How does PH’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.
- 2. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of PH? 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 NYSE 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.