In This Article:
With so many different financial models generating different conclusions, choosing the most relevant one to value a company can be daunting. In the case of Dover Corporation’s (NYSE:DOV), my discounted cash flow (DCF) model tells me that Dover Corporation’s (NYSE:DOV) is overvalued by 23.5%; however, my relative valuation metrics tell me that Dover Corporation’s (NYSE:DOV) is overvalued by 0.083%. Which model do I listen to and more importantly why?
Check out our latest analysis for Dover
A closer look at intrinsic valuation
Forecasting anything into the distant future is difficult and the same applies to forecasting free cash flows (FCFs) for businesses. This is why I’ve decided to use analyst FCF forecasts in my DCF to see what the consensus view is while also removing some subjectivity. If you’re unfamiliar with valuation, the assumption behind every DCF is that a firm’s true value is derived from the sum of all its future FCFs, which is why quality forecasts are important. When I discount all of DOV’s future FCFs by 12%, I obtain an equity value of $US$10.5b, then 147.70k shares outstanding are divided through. This results in an intrinsic value of $70.79. Check out the source of my intrinsic value here.,
Before we accept this value and move on, let’s take a look at how reliable it is. A key assumption in DCFs is that by the final year of our forecast horizon, which is year 5 in DOV’s case, a company is assumed to be mature and therefore FCF should be growing at a sustainable rate. At -10.66%, final year FCF growth is unsustainably low. If this assumption held true, DOV would shrink to a point where it would cease to exist very soon, which is a highly unlikely outcome. To improve our DCF analysis, we could extend the terminal year until FCF growth moderates to a more sustainable level around 1% to 5%. The downside is that forecasts are less reliable the further into the future they are.
A closer look at relative valuation
The basic principle of relative valuation is that two companies with near identical characteristics should be priced similarly. But a big issue here is actually finding companies that are similar to DOV, so I’ve used the Machinery industry as a proxy. The calculations for relative valuation are quite simple. By multiplying DOV’s earnings by the industry’s P/E ratio, we can obtain DOV’s fair value of $87.36, which tells us that it is overvalued. However, should we believe this result?
One quick way of finding out is to see if DOV shares a similar capital structure to the overall Machinery industry we are comparing it to. This is an important check since the P/E ratio, which we are using for our relative valuation, can be distorted by different capital structures. At 114.75, DOV’s D/E ratio is significantly higher than the average firm in the Machinery industry, which has a D/E ratio of 149.93%. Given the discrepancy of DOV’s D/E with the average Machinery firm, we could improve our analysis by using enterprise multiples like EV/Sales instead, which aren’t affected by different capital structures.