I am going to run you through how I calculated the intrinsic value of Stella-Jones Inc (TSX:SJ) using the discounted cash flow (DCF) method. If you want to learn more about this method, the basis for my calculations can be found in detail in the Simply Wall St analysis model. Also note that this article was written in April 2018 so be sure check the latest calculation for Stella-Jones here.

Crunching the numbers

I use what is known as the 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the initial phase has higher growth rates that plateau over time. To begin, I took the analyst consensus estimates of SJ’s levered free cash flow (FCF) over the next five years and discounted these figures at the cost of equity of 9.75%. 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 CA$639.20M. Want to understand how I arrived at this number? Take a look at our detailed analysis here.

The graph above shows how SJ’s top and bottom lines are expected to move in the future, which should give you some color on SJ’s outlook. Now we need to determine 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. Discounting the terminal value back five years gives us a present value of CA$2.06B.

The total value, or equity value, is then the sum of the present value of the cash flows, which in this case is CA$2.70B. In the final step we divide the equity value by the number of shares outstanding. This results in an intrinsic value of CA$38.87, which, compared to the current share price of CA$45.51, we find that Stella-Jones is fair value, maybe slightly overvalued and not available at a discount at this time.

Next Steps:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company.

For SJ, I’ve put together three relevant factors you should look at:

1. Financial Health: Does SJ 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.

2. Future Earnings: How does SJ’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 High Quality Alternatives: Are there other high quality stocks you could be holding instead of SJ? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!