Key insights

• Using 2-stage free cash flow to equity, the CDW estimate of fair value is $193
• With a share price of $226, CDW appears to be trading close to its estimated fair value
• Our fair value estimate is 23% below CDW's analyst price target of $250

How Far Is CDW Corporation (NASDAQ:CDW) From Its Intrinsic Value? Using the most recent financial data, we check whether the stock is fairly valued by discounting the company's projected future cash flows to today's value. One way to achieve this is to use the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We generally believe that the value of a company is the present value of all future cash generated. However, a DCF is just one valuation metric among many and is not without its flaws. If you still have burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

Check out our latest analysis for CDW

The numbers crunch

We use what is called a 2-stage model, which simply means that we have two different periods of growth rates for the company's cash flows. Generally, the first phase is a higher growth phase and the second phase is a lower growth phase. First, we need to get estimates of cash flows for the next ten years. Where possible we use analyst estimates. However, if these are not 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 take into account that growth tends to slow more in the early years than in later years.

In general, we assume that a dollar today is more valuable than a dollar in the future, and therefore the sum of these future cash flows is discounted to today's value:

10-year free cash flow (FCF) forecast.

(“Est” = FCF growth rate estimated by Simply Wall St)
Present Value of 10-Year Cash Flow (PVCF) = $9.7 billion

The second stage is also called the final value. This is the company's cash flow after the first stage. The Gordon Growth Formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year Treasury yield of 2.5%. We discount the final cash flows to today's value using a cost of equity of 7.4%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = $1.6 billion × (1 + 2.5%) ÷ (7.4% – 2.5%) = $33 billion

Present Value of Final Value (PVTV)= TV / (1 + r)¹⁰= $33 billion ÷ (1 + 7.4%)¹⁰= $16 billion

The total value or equity value is then the sum of the present value of the future cash flows, which in this case is $26 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 $226, the company appears to be around fair value at the time of writing. However, remember that this is just a rough estimate and like any complex formula, garbage in, garbage out.

Important assumptions

We would like to point out that the most important input factors for a discounted cash flow are the discount rate and of course the actual cash flows. You don't have to agree to these entries, I recommend repeating the calculations yourself and playing with them. The DCF also does not take into account the possible cyclicality of an industry or a company's future capital needs and therefore does not provide a complete picture of a company's potential performance. Since we consider CDW 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 takes debt into account. In this calculation we used 7.4%, which is based on a leveraged beta of 1.184. Beta is a measure of a stock's volatility compared to the overall market. We obtain our beta from the industry average of comparable companies worldwide, with a set limit of between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT analysis for CDW

It continues:

Valuation is just one side of the coin when creating your investment thesis and just one of many factors you need to evaluate for a company. DCF models are not the be-all and end-all of investment valuation. Instead, the best use of a DCF model is to test certain assumptions and theories to determine whether they would result in the company being under- or overvalued. If a company grows differently, or if its cost of equity or risk-free interest rate changes significantly, the outcome can be very different. For CDW, there are three key factors that you should research further:

1. Risks: For example, we discovered 1 warning sign for CDW what you should be aware of before investing here.
2. management:Have insiders added to their shares to take advantage of market sentiment about CDW's future prospects? Check out our management and board analysis with insights into CEO compensation and governance factors.
3. Other solid companies: Low debt, high returns on equity and good past performance are fundamental to a strong company. Check out our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered yet!

P.S. Simply Wall St updates its DCF calculation for every American stock daily. So if you want to find out the intrinsic value of another stock, just search here.

Do you have feedback on this article? Worried about the content? Get in touch directly with us. Alternatively, you can also send an email to editor-team (at) simplywallst.com.

This article from Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts using only an unbiased methodology and our articles are not intended as financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term focused analysis based on fundamental data. Note that our analysis may not reflect the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.