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Does the share price for Caterpillar Inc (NYSE:CAT) reflect it’s really worth? Today, I will calculate the stock’s intrinsic value using the discounted cash flow (DCF) method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model. Also note that this article was written in March 2018 so be sure check the latest calculation for Caterpillar here.
Crunching the numbers
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 forecast of CAT’s levered free cash flow (FCF) over the next five years and discounted these values at the cost of equity of 11.36%. When estimates weren’t available, I’ve extrapolated the average annual growth rate over the previous five years, capped at a reasonable level. This resulted in a present value of 5-year cash flow of US$22.99B. Keen to know how I arrived at this number? Read our detailed analysis here.
The infographic above illustrates how CAT’s earnings are expected to move in the future, which should give you some color on CAT’s outlook. Next, I calculate the terminal value, which is the business’s cash flow after the first stage. It’s appropriate to use the 10-year government bond rate of 2.8% as the perpetual growth rate, which is rightly below GDP growth, but more towards the conservative side. The present value of the terminal value after discounting it back five years is US$39.19B.
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 US$62.18B. To get the intrinsic value per share, we divide this by the total number of shares outstanding. This results in an intrinsic value of $104.05, which, compared to the current share price of $147.38, we see that Caterpillar is rather overvalued and not available at a discount at this time.
Next Steps:
Valuation is only one side of the coin in terms of building your investment thesis, and 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 CAT, I’ve compiled three important factors you should further research:
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Financial Health: Does CAT 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.
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Future Earnings: How does CAT’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.
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Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of CAT? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!