Today we briefly run the valuation methodology used to estimate the attractiveness of Cigna Corporation (NYSE:CI) as an investment opportunity by projecting its future cash flows and discounting them to today’s value. We will use the discounted cash flow (DCF) model. Don’t let the jargon fool you. The math behind it is actually pretty simple.
It is worth pointing out that the DCF is not perfect for all situations, as companies may be assessed in different ways. If you want to learn more about discounted cash flow, you can read more about the rationale behind this calculation in our Simply Wall St analytical model.
check out opportunities and risks in the US healthcare industry.
What is an estimated valuation?
We use what is called a two-step model. This simply means that he has two different periods in the company’s cash flow growth rate. Generally, the first stage is the high growth stage and the second stage is the low growth stage. First, we need to get an estimate of cash flow for the next 10 years. We use analyst estimates when available, but if these are not available, we extrapolate previous free cash flow (FCF) from previous estimates or reported values. Over this period, we expect companies with shrinking free cash flow to contract at a slower rate, and those with growing free cash flow to see slower growth. This is to reflect that growth tends to slow in the early years rather than in later years.
In general, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to get an estimate of present value.
10-Year Free Cash Flow (FCF) Estimate
|Leverage FCF ($, million)||$8.18 billion||US$10 billion||$8.6 billion||$9.01 billion||$9.14 billion||$9.28 billion||$9.44 billion||$9.61 billion||$9.79 billion||$9.97 billion|
|growth rate source||Analyst x 4||Analyst x 4||2 analysts||2 analysts||estimated @ 1.44%||Est @ 1.6%||estimated @ 1.71%||estimated @ 1.79%||estimated @ 1.85%||estimated @ 1.89%|
|Present Value ($, Millions) Discount @ 6.6%||$7.7 million||$8.8 million||US$7.1 million||$7 million||$6.6 million||$6.3 million||$6 million||US$5.8 million||$5.5 million||$5.2 million|
(“Est” = FCF growth rate estimated by Simply Wall St)
10-Year Present Value of Cash Flows (PVCF) = $66 billion
After calculating the present value of the future cash flows for the first 10 years, we need to calculate the terminal value. This takes into account all future cash flows after the first stage. A very conservative growth rate is used that cannot exceed the country’s GDP growth rate for a number of reasons. In this case, we used the 5-year average of 10-year government bond yields (2.0%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to their present value using a 6.6% cost of equity.
Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$10 billion × (1 + 2.0%) ÷ (6.6%– 2.0%) = US$219 billion
Present Value of Terminal Value (PVTV)= television / (1 + r)Ten= US$219 billion ÷ ( 1 + 6.6%)Ten= US$115 billion
The total value, or equity value, is the sum of the present value of the future cash flows, in this case US$181 billion. The final step is to divide the stock value by the number of outstanding shares. Compared to its current share price of US$324, the company is 45% cheaper than its current share price and looks like a good deal. However, evaluation is an imprecise tool, like a telescope. Move a few degrees and you’ll end up in another galaxy. Remember this.
We point out that the most important inputs to discounted cash flows are the discount rate and, of course, the actual cash flows. You do not have to consent to these inputs. I encourage you to redo the calculations yourself and play with them. The DCF also does not give a complete picture of a company’s potential performance, as it does not take into account the cyclicality of the industry or the company’s future capital requirements. Given that we see Cigna 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) that accounts for the debt. For this calculation we used 6.6% based on a leverage beta of 0.907. Beta is a measure of a stock’s volatility relative to the market as a whole. Our betas are derived from industry average betas of globally comparable companies and are capped between 0.8 and 2.0. This is a reasonable range for a stable business.
A company’s reputation is important, but it’s only one of many factors by which a company should be evaluated. The DCF model is not all about investment valuation. If possible, apply different cases and assumptions to see how they affect your company’s valuation. For example, a small adjustment to terminal value growth rate can dramatically change overall results. Can you understand why the company is trading at a discount to its intrinsic value?
- risk: taking risks, e.g. – Cigna is 1 warning sign I think you should know.
- future earnings: How does CI’s growth rate compare to its peers and the broader market? Manipulate the free analyst growth forecast charts to dig deeper into analyst consensus numbers for the next few years.
- Other solid businesses: Low debt, high return on equity and a strong past performance are the cornerstones of a strong business. Explore interactive stock listings with solid business fundamentals to see if there are other companies you haven’t considered!
PS. The Simply Wall St app conducts discounted cash flow valuations for all NYSE stocks on a daily basis. If you want to find calculations for other stocks, search here.
Valuation is complicated, but we’re here to help make it simple.
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This article by Simply Wall St is general in nature. We provide comments based on historical data and analyst projections using only unbiased methodologies and our articles are not intended as financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. We aim to deliver long-term focused analysis based on fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Is not …