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Highlights
- HP Inc. is currently trading at a significant discount to its estimated intrinsic value.
- The Discounted Cash Flow (DCF) model suggests the company could be undervalued.
- The two-stage growth model used in the reviewing accounts for both a high initial growth period.
HP Inc., operating in the technology sector with a strong focus on personal systems and printing solutions, is often a subject of discussion when it comes to understanding its true value. Given the current market environment, it is worth taking a closer look at whether HP (NYSE: HPQ) 's share price in October accurately reflects its intrinsic worth. A popular method for such an evaluation is the Discounted Cash Flow (DCF) model, which helps estimate the present value of a company’s future cash flows.
The Approach
The DCF model operates on a fundamental belief: a company's worth is the present value of all its future cash flows. To perform this calculation, a two-stage growth model is applied, which takes into account two distinct phases of growth. Initially, a company might experience faster growth, which tends to level off after a certain period. The goal is to project these cash flows for the first ten years and beyond, discounting them to their present value to arrive at an equity valuation.
Where possible, projections are based on estimates from industry experts. When such projections are unavailable, extrapolation from the company’s most recent free cash flow data is applied. This ensures that declining cash flow slows its rate of shrinkage, while growing cash flow gradually slows its rate of expansion. These adjustments reflect a realistic slowing down of growth as companies mature.
Long-Term Projections and Terminal Value
Once the initial 10-year period is accounted for, the Terminal Value is calculated, representing the value of cash flows beyond that period. For conservatism, a future growth rate is typically kept below a country’s GDP growth rate. In this case, a 2.5% growth rate, derived from the 5-year average of a 10-year government bond yield, was applied. The sum of the present value of future cash flows, both in the short term and the long term, gives the company’s total equity value.
Key Takeaways
After applying the DCF model, HP Inc.’s equity value comes out to approximately US$58 billion. When dividing this by the number of shares outstanding, it suggests that HP is trading at a 40% discount relative to its intrinsic value, with the current share price being around US$35.9. While the DCF model is a useful tool, it is also important to remember that such valuations are subject to many assumptions and can vary with changes in market conditions.
In conclusion, based on the DCF analysis, HP Inc. appears to be trading at an attractive discount to its estimated value, suggesting that the company may be undervalued in the current market.
