Yahoo Finance Calculating The Fair Value Of International Business Machines Corporation (NYSE:IBM)
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In this article I am going to calculate the intrinsic value of International Business Machines Corporation (NYSE:IBM) by taking the expected future cash flows and discounting them to today’s value. I will be using the discounted cash flows (DCF) model. Don’t get put off by the jargon, the math behind it is actually quite straightforward. If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not February 2019 then I highly recommend you check out the latest calculation for International Business Machines by following the link below.
Check out our latest analysis for International Business Machines
The method
I’m 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 perpetual stable growth rate. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. The sum of these cash flows is then discounted to today’s value.
5-year cash flow forecast
2019 | 2020 | 2021 | 2022 | 2023 | |
Levered FCF ($, Millions) | $12.67k | $12.52k | $12.89k | $11.50k | $11.90k |
Source | Analyst x8 | Analyst x8 | Analyst x2 | Analyst x1 | Analyst x1 |
Present Value Discounted @ 12.51% | $11.26k | $9.89k | $9.05k | $7.18k | $6.60k |
Present Value of 5-year Cash Flow (PVCF)= US$44b
The second stage is also known as Terminal Value, this is the business’s cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.7%. We discount this to today’s value at a cost of equity of 12.5%.
Terminal Value (TV) = FCF2023 × (1 + g) ÷ (r – g) = US$12b × (1 + 2.7%) ÷ (12.5% – 2.7%) = US$125b
Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$125b ÷ ( 1 + 12.5%)5 = US$69b
The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is US$113b. The last step is to then divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) then we use the equivalent number. This results in an intrinsic value of $124.66. Compared to the current share price of $138.03, the stock is fair value, maybe slightly overvalued and not available at a discount at this time.
Important assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. If you don’t agree with my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at International Business Machines as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 12.5%, which is based on a levered beta of 1.345. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
Next Steps:
Although the valuation of a company is important, it shouldn’t be the only metric you look at when researching a company. For IBM, there are three important aspects you should look at:
Financial Health: Does IBM 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 IBM’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 IBM? 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.
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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. On rare occasion, data errors may occur. Thank you for reading.
