A look at the fair value of DR Horton, Inc. (NYSE:DHI)

Key findings

• Using the 2-step free cash flow to equity, DR Horton’s fair value estimate is $187.
• The current share price of $177 suggests that DR Horton may be trading close to its fair value
• Our fair value estimate is in line with DR Horton’s analyst price target of $187.

In this article, we will estimate the intrinsic value of DR Horton, Inc. (NYSE:DHI) 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. Before you think you can’t understand it, just keep reading! It’s actually a lot less complex than you think.

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 DR Horton

What is the estimated value?

We use what is called a 2-stage model, which simply means that we have two different growth periods for the company’s cash flows. Generally speaking, the first stage is one of higher growth, and the second stage is one of lower growth. First, we need to estimate the next ten years’ worth of cash flows. Where possible, we use analyst estimates, but when these aren’t 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 more in the early years than in later years.

A DCF is all about the idea that a dollar in the future is worth less than a dollar today. Therefore, we need to discount the sum of these future cash flows to arrive at an estimate of present value:

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) = 27 billion US dollars

After calculating the present value of future cash flows in the first 10-year period, we need to calculate the terminal value that takes into account all future cash flows after the first 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 8.5%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = 4.5 billion US dollars × (1 + 2.4%) ÷ (8.5% – 2.4%) = 76 billion US dollars

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 76 billion US dollars ÷ (1 + 8.5%)¹⁰= 34 billion US dollars

The total value or equity value is then the sum of the present value of future cash flows, which in this case is $61 billion. In the final step, we divide the equity value by the number of shares outstanding. Compared to the current share price of $177, the company appears roughly fairly valued at a 5.3% 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.

The assumptions

We would like to point out that the key inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you disagree 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 a company’s future capital needs and therefore does not provide a complete picture of a company’s potential performance. Since we consider DR Horton 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 8.5%, which is based on a leveraged beta of 1.326. 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 DR Horton

Next Steps:

Although a company’s valuation is important, it should not be the only metric you consider when researching a company. It is not possible to get a foolproof valuation using a DCF model. A better way would be to apply different cases and assumptions and see how they would affect the company’s valuation. For example, changes in the company’s cost of equity or risk-free interest rate can significantly affect the valuation. For DR Horton, we have compiled three relevant points to consider:

1. Financial health: Does DHI have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors such as leverage and risk.
2. management:Have insiders increased their shares to capitalize on market sentiment regarding DHI’s future prospects? Read our management and board analysis with insights into CEO compensation and governance factors.
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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