Calculating the fair value of Avista Corporation (NYSE:AVA)

Key findings

• The projected fair value for Avista is $42.92 based on the dividend discount model

• Avista’s share price is at $36.05, a similar level to the estimated fair value

• Our fair value estimate is 7.3% above Avista’s analyst price target of $40.00.

Does the July share price of Avista Corporation (NYSE:AVA) reflect what it’s really worth? Today we’ll estimate the stock’s intrinsic value by taking the company’s projected future cash flows and discounting them to today’s value. Our analysis will use the Discounted Cash Flow (DCF) model. Models like these may seem incomprehensible to a layperson, but they’re relatively easy to follow.

We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one valuation metric among many and is not without its flaws. For those who enjoy stock analysis, the Simply Wall St analysis model presented here might be of interest.

Check out our latest analysis for Avista

Is Avista fairly valued?

Because Avista operates in the integrated utilities sector, we need to calculate intrinsic value a little differently. Instead of using free cash flows, which are difficult to estimate and often unreported by analysts in this industry, we use dividend payments per share (DPS). Unless a company pays out the majority of its free cash flow as dividends, this method typically underestimates the value of the stock. It uses the “Gordon Growth Model,” which simply assumes that dividend payments will continue to grow forever at a sustainable growth rate. For a number of reasons, it uses a very conservative growth rate that cannot exceed that of a company’s gross domestic product (GDP). In this case, we used the 5-year average of the 10-year Treasury bond yield (2.4%). The expected dividend per share is then discounted to today’s value using a cost of equity of 6.1%. Compared to the current share price of $36.1, the company appears to be roughly fairly valued at a 16% discount to the current share price. However, keep in mind that this is only an approximate valuation and that, as with any complex formula, where there’s garbage in, there’s garbage out.

Value per share = Expected dividend per share / (Discount rate – Perpetual growth rate)

= 2.1 USD / (6.1% – 2.4%)

= 42.9 US dollars

Important assumptions

The key 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 repeating the calculations yourself and playing around with them. The DCF also doesn’t take into account the potential cyclicality of an industry or a company’s future capital needs and therefore doesn’t provide a complete picture of a company’s potential performance. Since we consider Avista 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 6.1%, which is based on a leveraged beta of 0.800. Beta is a measure of a stock’s volatility relative to the overall market. We get our beta from the industry average beta of globally comparable companies with a set limit between 0.8 and 2.0, which is a reasonable range for a stable company.

The story goes on

SWOT analysis for Avista

Strength

weakness

Opportunity

Danger

Go on:

While a company’s valuation is important, it is only one of many factors you need to evaluate 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 see if they would lead to an undervaluation or overvaluation of the company. For example, slightly adjusting the terminal value growth rate can dramatically change the overall result. For Avista, we’ve put together three other points you should examine in more detail:

1. Risks: You should be aware 4 warning signs for Avista (1 is potentially serious!) that we uncovered before considering investing in the company.

2. Future income: How does AVA’s growth rate compare to competitors and the overall market? Learn more about analyst consensus numbers for the coming years by using our free chart of analyst growth expectations.

3. Other high-quality alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get an idea of ​​what else you might be missing out on!

PS The Simply Wall St app runs a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks, just search here.

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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not 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 analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.

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