Texas Roadhouse, Inc. (NASDAQ:TXRH) intrinsic value may be 23% below share price

Key findings

• Using the 2-step free cash flow to equity, the fair value of Texas Roadhouse is $129.
• Texas Roadhouse’s share price of $168 suggests the company may be 30% overvalued
• The analyst price target of $174 for TXRH is 35% above our fair value estimate

Today we’ll go over one way to estimate the intrinsic value of Texas Roadhouse, Inc. (NASDAQ:TXRH) by taking the company’s projected future cash flows and discounting them to today’s value. One way to do this is by applying the Discounted Cash Flow (DCF) model. This may sound complicated, but it’s actually quite simple!

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 it is not without its flaws. If you still have some burning questions about this type of valuation, take a look at Simply Wall St’s analysis model.

Check out our latest analysis for Texas Roadhouse

Step by step through the calculation

We use a two-stage DCF model which, as the name suggests, considers two phases of growth. The first stage is generally a higher growth phase that stabilizes toward the terminal value captured in the second “steady growth” stage. First, we need to obtain estimates of the next ten years 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.

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:

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) = 3.2 billion US dollars

The second phase is also called the terminal value, which is the company’s cash flow after the first phase. 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 7.5%.

Final value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = $564 million × (1 + 2.4%) ÷ (7.5% – 2.4%) = $11 billion

Present value of terminal value (PVTV)= TV / (1 + r)¹⁰= 11 billion US dollars ÷ (1 + 7.5%)¹⁰= 5.4 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 $8.6 billion. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of $168, the company appears slightly overvalued at the time of writing. However, valuations are imprecise instruments, much like a telescope – move a few degrees and you end up in another galaxy. Keep this in mind.

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. Part of investing is making your own assessment of a company’s future performance, so try the calculation yourself and check your own assumptions. DCF also does not take into account the potential 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 are looking at Texas Roadhouse 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 7.5%, which is based on a leveraged beta of 1.121. Beta is a measure of a stock’s volatility relative to the market as a whole. 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 Texas Roadhouse

Go on:

Valuation is only one side of the coin when building your investment thesis and 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. 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 valuation. What is causing the stock price to exceed intrinsic value? For Texas Roadhouse, there are three fundamental aspects you should investigate further:

1. Risks: For example, we found 1 warning sign for Texas Roadhouse that you need to consider before investing here.
2. Future income: How does TXRH’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: 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 NASDAQGS 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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