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A Look At The Intrinsic Value Of Emerson Electric Co. (NYSE:EMR)

Key Insights

  • Using the 2 Stage Free Cash Flow to Equity, Emerson Electric fair value estimate is US$122

  • Emerson Electric's US$105 share price indicates it is trading at similar levels as its fair value estimate

  • The US$117 analyst price target for EMR is 4.0% less than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Emerson Electric Co. (NYSE:EMR) by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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See our latest analysis for Emerson Electric

Step By Step Through The Calculation

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. In the first stage we need to estimate the cash flows to the business over the next ten years. 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) forecast

2024

2025

2026

2027

2028

2029

2030

2031

2032

2033

Levered FCF ($, Millions)

US$2.67b

US$3.33b

US$3.78b

US$4.44b

US$4.48b

US$4.53b

US$4.60b

US$4.68b

US$4.76b

US$4.86b

Growth Rate Estimate Source

Analyst x8

Analyst x8

Analyst x4

Analyst x1

Analyst x1

Est @ 1.16%

Est @ 1.50%

Est @ 1.74%

Est @ 1.90%

Est @ 2.02%

Present Value ($, Millions) Discounted @ 7.8%

US$2.5k

US$2.9k

US$3.0k

US$3.3k

US$3.1k

US$2.9k

US$2.7k

US$2.6k

US$2.4k

US$2.3k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$28b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. 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 7.8%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$4.9b× (1 + 2.3%) ÷ (7.8%– 2.3%) = US$90b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$90b÷ ( 1 + 7.8%)10= US$42b

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$70b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$105, the company appears about fair value at a 14% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
dcf

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 Emerson Electric 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 7.8%, which is based on a levered beta of 1.205. 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 Emerson Electric

Strength

  • Earnings growth over the past year exceeded its 5-year average.

  • Debt is well covered by earnings.

Weakness

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

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

Opportunity

  • Annual earnings are forecast to grow for the next 3 years.

  • Current share price is below our estimate of fair value.

Threat

  • Debt is not well covered by operating cash flow.

  • Dividends are not covered by cash flow.

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

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. 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. For Emerson Electric, we've put together three relevant aspects you should further research:

  1. Risks: Be aware that Emerson Electric is showing 2 warning signs in our investment analysis , you should know about...

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for EMR's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

  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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.