Calculating the fair value of Booz Allen Hamilton Holding Corporation (NYSE:BAH)

Key findings

• Using the 2-step free cash flow to equity, the fair value of Booz Allen Hamilton Holding is $160.

• With a share price of $154, Booz Allen Hamilton Holding appears to be trading close to its estimated fair value

• Analysts’ price target for BAH is $167, 4.2% above our fair value estimate.

How far is Booz Allen Hamilton Holding Corporation (NYSE:BAH) from its intrinsic value? Using the most recent financial data, we will check if the stock is fairly valued by taking the company’s projected future cash flows and discounting them to today’s value. This is done using the Discounted Cash Flow (DCF) model. This may sound complicated, but it’s actually quite simple!

However, keep in mind that there are many ways to estimate the value of a company, and a DCF is just one of them. If you still have pressing questions about this type of valuation, take a look at Simply Wall St’s analysis model.

Check out our latest analysis for Booz Allen Hamilton Holding

Step by step through the calculation

We use the two-stage growth model, which simply means that we consider two stages of the company’s growth. In the early stage, the company might have a higher growth rate, and in the second stage, a stable growth rate is usually assumed. In the first stage, we need to estimate the company’s cash flows for the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume that companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will slow their growth rate, over this period. We do this to take into account that growth tends to slow down more in the early years than in later years.

In general, we assume that a dollar today is worth more than a dollar in the future. Therefore, we discount the value of these future cash flows to their estimated value in today’s dollars:

The story goes on

Estimation of free cash flow (FCF) over 10 years

(“Est” = FCF growth rate, estimated by Simply Wall St)
Present value of 10-year cash flow (PVCF) = 6.3 billion US dollars

We now need to calculate the terminal value that takes into account all future cash flows after this ten-year period. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year Treasury yield of 2.4%. We discount the terminal cash flows to today’s value at a cost of equity of 6.7%.

Final value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = 1.2 billion US dollars × (1 + 2.4%) ÷ (6.7% – 2.4%) = 28 billion US dollars

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 28 billion US dollars ÷ (1 + 6.7%)¹⁰= 14 billion US dollars

Total value is the sum of the next ten years’ cash flows plus the discounted terminal value, which gives the total value of equity, which in this case is $21 billion. To get the intrinsic value per share, we divide that by the total number of shares outstanding. Compared to the current share price of $154, the company seems roughly fairly valued at a 4.1% discount to the current share price. However, keep in mind that this is only an approximate valuation and as with any complex formula, where there’s garbage in, there’s garbage out.

Important assumptions

The main 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 possible 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 Booz Allen Hamilton Holding 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 6.7%, which is based on a leveraged beta of 0.939. 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 an imposed limit of between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT Analysis for Booz Allen Hamilton Holding

Strength

weakness

Opportunity

Danger

Go on:

While valuing a company is important, ideally it should not be the only analysis you look at for a company. The DCF model is not a perfect stock valuation tool. Rather, it should be viewed as a guide to “what assumptions must hold for this stock to be under/overvalued.” For example, changes in the company’s cost of equity or risk-free interest rate can significantly affect the valuation. For Booz Allen Hamilton Holding, we have compiled three basic elements you should evaluate:

1. Risks: For this purpose, you should consult the 1 warning sign we discovered it at Booz Allen Hamilton Holding.

2. Future income: How does BAH’s growth rate compare to its 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: Like a good all-rounder? Explore our interactive list of high-quality stocks to get a sense of what else you might be missing out on!

PS The Simply Wall St app does 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 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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