Does This Valuation Of Simpson Manufacturing Co., Inc. (NYSE:SSD) Imply Investors Are Overpaying?
Key Insights
The projected fair value for Simpson Manufacturing is US$128 based on 2 Stage Free Cash Flow to Equity
Simpson Manufacturing's US$172 share price signals that it might be 34% overvalued
Analyst price target for SSD is US$192, which is 50% above our fair value estimate
Today we will run through one way of estimating the intrinsic value of Simpson Manufacturing Co., Inc. (NYSE:SSD) by taking the expected future cash flows and discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
See our latest analysis for Simpson Manufacturing
The Method
We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
Levered FCF ($, Millions) | US$304.9m | US$291.4m | US$284.5m | US$281.9m | US$282.3m | US$284.6m | US$288.4m | US$293.2m | US$298.9m | US$305.2m |
Growth Rate Estimate Source | Analyst x1 | Est @ -4.44% | Est @ -2.36% | Est @ -0.90% | Est @ 0.12% | Est @ 0.83% | Est @ 1.33% | Est @ 1.68% | Est @ 1.93% | Est @ 2.10% |
Present Value ($, Millions) Discounted @ 7.1% | US$285 | US$254 | US$231 | US$214 | US$200 | US$188 | US$178 | US$169 | US$161 | US$153 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$2.0b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.5%. We discount the terminal cash flows to today's value at a cost of equity of 7.1%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$305m× (1 + 2.5%) ÷ (7.1%– 2.5%) = US$6.7b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$6.7b÷ ( 1 + 7.1%)10= US$3.4b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$5.4b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$172, the company appears potentially overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.
Important Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 7.1%, which is based on a levered beta of 1.128. 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 declined over the past year.
Dividend is low compared to the top 25% of dividend payers in the Building market.
Opportunity
Annual earnings are forecast to grow for the next 2 years.
Good value based on P/E ratio compared to estimated Fair P/E ratio.
Threat
Annual earnings are forecast to grow slower than the American market.
Next Steps:
Although the valuation of a company is important, it 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. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Why is the intrinsic value lower than the current share price? For Simpson Manufacturing, we've put together three relevant elements you should explore:
Risks: We feel that you should assess the 1 warning sign for Simpson Manufacturing we've flagged before making an investment in the company.
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.
Other High Quality Alternatives: Do you like a good all-rounder? 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 updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock 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.