A look at the fair value of SJW Group (NYSE:SJW)

Key findings

• The estimated fair value of SJW Group is $48.12 based on the dividend discount model
• With a share price of $54.75, SJW Group appears to be trading close to its estimated fair value
• The analyst price target of $64.75 for SJW is 35% above our fair value estimate

Today we will run through a valuation methodology to assess the attractiveness of SJW Group (NYSE:SJW) as an investment opportunity. To do this, we will take the company’s projected future cash flows and discount 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 are relatively easy to follow.

We would like to point out that there are many ways to value a company and that each method, like DCF, has advantages and disadvantages in certain scenarios. Those who want to learn more about intrinsic value should check out Simply Wall St’s analysis model.

Check out our latest analysis for SJW Group

The method

Because SJW Group operates in the water utilities sector, we need to calculate intrinsic value a little differently. This approach uses dividends per share (DPS) because free cash flow is difficult to estimate and often unreported by analysts. Unless a company pays out the majority of its free cash flow as dividends, this method will typically underestimate the value of the stock. It uses the “Gordon Growth Model,” which simply assumes that dividend payments will continue to grow at a sustainable growth rate forever. For a number of reasons, a very conservative growth rate is used, which cannot exceed that of a company’s gross domestic product (GDP). In this case, we used the 5-year average 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%. Relative to the current share price of $54.8, the company seems about fair at the time of writing. However, ratings are imprecise instruments, much like a telescope – shift a few degrees and you end up in a different galaxy. Keep that in mind.

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

= 1.8 US dollars / (6.1% – 2.4%)

= 48.1 US dollars

The assumptions

The above calculation relies heavily on two assumptions. The first is the discount rate and the other is the cash flows. You don’t have to agree with these inputs, I recommend repeating the calculations yourself and playing with them. 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 SJW Group 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 an imposed limit of between 0.8 and 2.0 which is a reasonable range for a stable company.

SWOT analysis for SJW Group

Next Steps:

While the DCF calculation is important, it shouldn’t be the only metric you consider when researching a company. It’s not possible to get a foolproof valuation using a DCF model. Rather, it should be viewed as a guide to “what assumptions need to hold for this stock to be under/overvalued.” If a company grows at a different rate, or if its cost of equity or risk-free rate changes significantly, the outcome could look very different. For SJW Group, we’ve compiled three additional elements for you to examine:

1. Risks: A typical example: We discovered 3 warning signs for the SJW Group You should be aware of this, and one of them is important.
2. management:Have insiders increased their shares to capitalize on market sentiment regarding SJW’s future prospects? Read our management and board analysis with insights into CEO compensation and governance factors.
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 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.

Do you have feedback on this article? Are you concerned about the content? Get in touch directly from us. Alternatively, send an email to editorial-team (at) simplywallst.com.

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.

Do you have feedback on this article? Are you interested in the content? Contact us directly. Alternatively, send an email to [email protected]