A look at the fair value of Chevron Corporation (NYSE:CVX)

Does Chevron Corporation’s (NYSE:CVX) September Stock Price Reflect What It’s Really Worth? Today we are going to estimate the intrinsic value of the stock by projecting its future cash flows and then discounting them to the present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. There really isn’t much to do, although it may seem quite complex.

Remember though that there are many ways to estimate the value of a business and a DCF is just one method. For those who are passionate about stock analysis, the Simply Wall St analysis template here may interest you.

Check out our latest analysis for Chevron

Is Chevron valued enough?

We will use a two-stage DCF model which, as the name suggests, takes into account two stages of growth. The first stage is usually a period of higher growth which stabilizes towards the terminal value, captured in the second period of “sustained growth”. To begin with, we need to obtain cash flow estimates for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.

Generally, we assume that a dollar today is worth more than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:

Estimated free cash flow (FCF) over 10 years

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Leveraged FCF ($, millions) $32.9 billion $29.2 billion $24.2 billion $20.9 billion $19.1 billion $18.1 billion $17.5 billion $17.2 billion US$17.1 billion US$17.1 billion
Growth rate estimate Source Analyst x11 Analyst x6 Analyst x3 Analyst x2 East @ -8.69% Is @ -5.5% Is @ -3.27% Is @ -1.71% Is @ -0.61% Is 0.15%
Present value (millions of dollars) discounted at 7.2% $30,700 $25,400 $19,600 $15,900 $13,500 $11,900 $10,700 $9,900 $9,100 $8.5,000

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $155 billion

The second stage is also known as the terminal value, it is the cash flow of the business after the first stage. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.9%. We discount terminal cash flows to present value at a cost of equity of 7.2%.

Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = $17 billion × (1 + 1.9%) ÷ (7.2%–1.9%) = $332 billion

Present value of terminal value (PVTV)= TV / (1 + r)ten= $332 billion ÷ (1 + 7.2%)ten= $166 billion

The total value, or equity value, is then the sum of the present value of future cash flows, which in this case is $321 billion. The final step is to divide the equity value by the number of shares outstanding. Compared to the current share price of $160, the company appears to be about fair value at a 2.5% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.

NYSE: CLC Discounted Cash Flow September 11, 2022

The hypotheses

We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. The DCF also does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we view Chevron 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 factors in debt. In this calculation, we used 7.2%, which is based on a leveraged beta of 1.239. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

Let’s move on :

While important, calculating DCF shouldn’t be the only metric to consider when researching a business. DCF models are not the be-all and end-all of investment valuation. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. If a company grows at a different pace, or if its cost of equity or risk-free rate changes sharply, output may be very different. For Chevron, we have compiled three relevant factors that you should consider in more detail:

  1. Risks: For example, we discovered 1 warning sign for Chevron which you should be aware of before investing here.
  2. Future earnings: How does CVX’s growth rate compare to its peers and the wider market? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
  3. Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!

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

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

Calculation of discounted cash flows for each share

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