Does Denny’s Corporation’s share price in September (NASDAQ: DENN) reflect its true value? Today we’re going to estimate the intrinsic value of the stock by estimating the company’s future cash flows and discounting them to their present value. To this end, we will take advantage of the Discounted Cash Flow (DCF) model. Before you think you won’t be able to figure it out, read on! It’s actually a lot less complex than you might imagine.
Keep in mind, however, that there are many ways to estimate the value of a business and that a DCF is just one method. If you would like to know more about discounted cash flows, the rationale for this calculation can be read in detail in the Simply Wall St analysis model.
We use what is called a two-step model, which simply means that we have two different periods of growth rate for the cash flow of the business. Usually, the first stage is higher growth, and the second stage is a lower growth stage. To begin with, we need to get cash flow estimates for the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or stated value. We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.
A DCF is based on the idea that a dollar in the future is worth less than a dollar today, and therefore the sum of those future cash flows is then discounted to today’s value. :
10-year Free Cash Flow (FCF) estimate
|Leverage FCF ($, Millions)||US $ 69.0 million||US $ 70.6 million||US $ 74.1 million||US $ 73.3 million||US $ 73.2 million||US $ 73.5 million||US $ 74.2 million||US $ 75.2 million||US $ 76.3 million||US $ 77.5 million|
|Source of growth rate estimate||Analyst x2||Analyst x1||Analyst x1||Is @ -1.09%||East @ -0.17%||Is @ 0.48%||Is 0.93%||Is @ 1.25%||Est @ 1.47%||East @ 1.63%|
|Present value (in millions of dollars) discounted at 8.5%||US $ 63.6||US $ 59.9||US $ 58.0||$ 52.9||$ 48.7||US $ 45.1||US $ 41.9||US $ 39.1||US $ 36.6||$ 34.3|
(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = 480 million US dollars
After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 8.5%.
Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US $ 78 million × (1 + 2.0%) ÷ (8.5% – 2.0%) = US $ 1.2 billion
Present value of terminal value (PVTV)= TV / (1 + r)ten= US $ 1.2 billion ÷ (1 + 8.5%)ten= US $ 537 million
The total value is the sum of the cash flows for the next ten years plus the final present value, which gives the total value of equity, which in this case is US $ 1.0 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of $ 16.5, the company appears to be around fair value at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.
NasdaqCM: DENN Discounted Cash Flow September 26, 2021
We draw your attention to the fact that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Denny’s as a potential shareholder, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which takes into account debt. In this calculation, we used 8.5%, which is based on a leveraged beta of 1.380. Beta is a measure of the volatility of a stock relative to the market as a whole. We get our beta from the industry average beta from globally comparable companies, with a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable business.
While a business valuation is important, it shouldn’t be the only metric you look at when researching a business. It is not possible to achieve a rock-solid valuation with a DCF model. Rather, it should be seen as a guide to “what assumptions must be true for this stock to be under / overvalued?” For example, if the terminal value growth rate is adjusted slightly, it can dramatically change the overall result. For Denny’s, there are three essentials you should be looking at:
- Risks: As an example, we found 4 warning signs for Denny’s that you need to consider before investing here.
- Management: Have insiders increased their stocks to take advantage of market sentiment about DENN’s future prospects? Check out our management and board analysis with information on CEO compensation and governance factors.
- Other strong companies: 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 businesses you may not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for each NASDAQCM share. If you want to find the calculation for other actions just search here.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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