January 7, 2025
How far off is Costco Wholesale Corporation ( NASDAQ:COST ) from its intrinsic value? Using the most recent financial data, we'll take a look at whether the stock is fairly priced by taking the forecast future cash flows of the company and discounting them back to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. It may sound complicated, but actually it is quite simple!
We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model .
See our latest analysis for Costco Wholesale
We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate 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.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
|
2025 |
2026 |
2027 |
2028 |
2029 |
2030 |
2031 |
2032 |
2033 |
2034 |
|
|
Levered FCF ($, Millions) |
US$7.14b |
US$8.13b |
US$9.70b |
US$10.9b |
US$13.6b |
US$15.3b |
US$16.8b |
US$18.0b |
US$19.1b |
US$20.0b |
|
Growth Rate Estimate Source |
Analyst x6 |
Analyst x8 |
Analyst x4 |
Analyst x3 |
Analyst x2 |
Est @ 12.43% |
Est @ 9.49% |
Est @ 7.43% |
Est @ 5.98% |
Est @ 4.98% |
|
Present Value ($, Millions) Discounted @ 5.9% |
US$6.7k |
US$7.3k |
US$8.2k |
US$8.6k |
US$10.2k |
US$10.8k |
US$11.2k |
US$11.4k |
US$11.4k |
US$11.3k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF)
= US$97b
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 2.6%. We discount the terminal cash flows to today's value at a cost of equity of 5.9%.
Terminal Value (TV) = FCF 2034 × (1 + g) ÷ (r – g) = US$20b× (1 + 2.6%) ÷ (5.9%– 2.6%) = US$624b
Present Value of Terminal Value (PVTV) = TV / (1 + r) 10 = US$624b÷ ( 1 + 5.9%) 10 = US$351b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$448b. 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$923, the company appears about fair value at a 8.6% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual 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 Costco Wholesale 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 5.9%, which is based on a levered beta of 0.800. 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.
Strength
Weakness
Opportunity
Threat
Valuation is only one side of the coin in terms of building your investment thesis, and it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Costco Wholesale, we've compiled three fundamental elements you should assess:
Risks : We feel that you should assess the 1 warning sign for Costco Wholesale we've flagged before making an investment in the company.
Management :Have insiders been ramping up their shares to take advantage of the market's sentiment for COST'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. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks 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.
