Simpson Manufacturing Co., Inc.'s (NYSE:SSD) Intrinsic Value Is Potentially 21% Below Its Share Price

Key Insights

• Simpson Manufacturing's estimated fair value is US$160 based on 2 Stage Free Cash Flow to Equity

• Simpson Manufacturing's US$201 share price signals that it might be 26% overvalued

• The US$197 analyst price target for SSD is 23% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Simpson Manufacturing Co., Inc. (NYSE:SSD) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

Check out our latest analysis for Simpson Manufacturing

The Calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. 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.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$262.1m	US$375.4m	US$383.4m	US$391.8m	US$400.4m	US$409.4m	US$418.6m	US$428.1m	US$437.8m	US$447.8m
Growth Rate Estimate Source	Analyst x2	Analyst x3	Est @ 2.13%	Est @ 2.18%	Est @ 2.21%	Est @ 2.24%	Est @ 2.25%	Est @ 2.26%	Est @ 2.27%	Est @ 2.28%
Present Value ($, Millions) Discounted @ 7.6%	US$244	US$324	US$308	US$292	US$278	US$264	US$251	US$238	US$226	US$215

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$2.6b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 (2.3%) 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 7.6%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$448m× (1 + 2.3%) ÷ (7.6%– 2.3%) = US$8.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$8.6b÷ ( 1 + 7.6%)¹⁰= US$4.1b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$6.8b. 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$201, the company appears slightly overvalued at the time of writing. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf

The Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. 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 Simpson Manufacturing 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 7.6%, which is based on a levered beta of 1.155. 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.

SWOT Analysis for Simpson Manufacturing

Strength

• Debt is not viewed as a risk.

Weakness

• Earnings growth over the past year underperformed the Building industry.

• Dividend is low compared to the top 25% of dividend payers in the Building market.

• Expensive based on P/E ratio and estimated fair value.

Opportunity

• Annual earnings are forecast to grow for the next 2 years.

Threat

• Annual earnings are forecast to grow slower than the American market.

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess 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 instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a premium to intrinsic value? For Simpson Manufacturing, we've compiled three important aspects you should further research:

1. Risks: As an example, we've found 1 warning sign for Simpson Manufacturing that you need to consider before investing here.

2. Future Earnings: How does SSD'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 Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

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.

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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.