Does the New Jersey Resources Corporation (NYSE: NJR) share price in May reflect what it is really worth? Today we’re going to estimate the intrinsic value of the stock by projecting its future cash flows and then discounting them to present value. We will use the Discounted Cash Flow (DCF) model on this occasion. Patterns like these may seem beyond a layman’s comprehension, but they are easy enough to follow.
We would like to point out that there are many ways to assess a business and, like DCF, each technique has advantages and disadvantages in certain scenarios. Anyone interested in learning a little more about intrinsic value should read Simply Wall St analysis model.
Check out our latest analysis of New Jersey resources
We have to calculate the value of New Jersey Resources slightly differently from other stocks because it is a gas utility company. In this approach, dividends per share (DPS) are used because free cash flow is difficult to estimate and often goes unreported by analysts. This often underestimates the value of a stock, but it can still be good in comparison to the competition. The “Gordon Growth Model” is used, which simply assumes that dividend payments will continue to increase at a sustainable growth rate forever. The dividend is expected to grow at an annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.0%. We then discount this figure to present value at a cost of equity of 5.8%. Compared to the current share price of US $ 42.7, the company is around fair value at the time of writing. Remember though, this is only a rough estimate, and like any complex formula – garbage in, garbage out.
Value per share = expected dividend per share / (discount rate – perpetual growth rate)
= $ 1.5 / (5.8% – 2.0%)
= $ 39.1
The above calculation is very dependent on two assumptions. One is the discount rate and the other is cash flow. If you don’t agree with these results, try the calculation yourself and play with the assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we view New Jersey Resources 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 into account debt. In this calculation, we used 5.8%, which is based on a leverage beta of 0.800. Beta is a measure of the volatility of a stock, relative 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.
Valuation is only one side of the coin in terms of building your investment thesis, and it’s just one of the many factors you need to evaluate for a business. DCF models are not the alpha and omega of investment valuation. Preferably, you would apply different cases and assumptions and see how they would impact the valuation of the business. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different. For New Jersey resources, there are three fundamental aspects that you should consider in more detail:
- Risks: Be aware that New Jersey Resources displays 2 warning signs in our investment analysis , and 1 of these is significant …
- Future income: How does NJR’s growth rate compare to its peers and to the market in general? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth forecast chart.
- Other strong companies: Low debt, high returns on equity, and good past performance are essential to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app performs a daily discounted cash flow assessment for every NYSE share. If you want to find the calculation for other actions, just search here.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals or your financial situation. We aim to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative information. Simply Wall St has no position in any of the stocks mentioned.
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