Key Insights
- The projected fair value for Hubbell is US$362 based on 2 Stage Free Cash Flow to Equity
- Hubbell's US$391 share price indicates it is trading at similar levels as its fair value estimate
- Analyst price target for HUBB is US$415, which is 15% above our fair value estimate
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Hubbell Incorporated (NYSE:HUBB) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.
Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
The Method
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) forecast
| 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
| Levered FCF ($, Millions) | US$857.9m | US$932.6m | US$991.9m | US$1.04b | US$1.08b | US$1.13b | US$1.17b | US$1.21b | US$1.25b | US$1.29b |
| Growth Rate Estimate Source | Analyst x9 | Analyst x9 | Analyst x1 | Est @ 4.85% | Est @ 4.28% | Est @ 3.88% | Est @ 3.60% | Est @ 3.40% | Est @ 3.26% | Est @ 3.17% |
| Present Value ($, Millions) Discounted @ 8.0% | US$794 | US$800 | US$788 | US$765 | US$738 | US$710 | US$681 | US$652 | US$624 | US$596 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$7.1b
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.9%. We discount the terminal cash flows to today's value at a cost of equity of 8.0%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$1.3b× (1 + 2.9%) ÷ (8.0%– 2.9%) = US$26b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$26b÷ ( 1 + 8.0%)10= US$12b
The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$19b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$391, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
The 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 Hubbell 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 8.0%, which is based on a levered beta of 1.166. 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.
Check out our latest analysis for Hubbell
SWOT Analysis for Hubbell
- Earnings growth over the past year exceeded the industry.
- Debt is well covered by earnings and cashflows.
- Dividends are covered by earnings and cash flows.
- Earnings growth over the past year is below its 5-year average.
- Dividend is low compared to the top 25% of dividend payers in the Electrical market.
- Expensive based on P/E ratio and estimated fair value.
- Annual earnings are forecast to grow for the next 3 years.
- Annual earnings are forecast to grow slower than the American market.
Moving On:
Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For Hubbell, there are three additional items you should further research:
- Risks: As an example, we've found 1 warning sign for Hubbell that you need to consider before investing here.
- Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for HUBB's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- 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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.
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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.