Calculating The Fair Value Of SJW Group (NASDAQ:SJW)

Simply Wall St.11-22 18:20

Key Insights SJW Group's estimated fair value is US$52.67 based on Dividend Discount Model Current share price of US$55.35 suggests SJW Group is potentially trading close to its fair value Our ...

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Using the most recent financial data, we'll take a look at whether the stock is fairly priced  by taking the forecast future cash flows of the company and discounting them back to today's value.  The Discounted Cash Flow (DCF) model is the tool we will apply to do this.  Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.  Remember though, that there are many ways to estimate a company's value, and a DCF is just one method.  If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.  See our latest analysis for SJW Group  Is SJW Group Fairly Valued?   As SJW Group operates in the water utilities sector, we need to calculate the intrinsic value slightly differently.  Instead of using free cash flows, which are hard to estimate and often not reported by analysts in this industry, dividends per share (DPS) payments are used.  This often underestimates the value of a stock, but it can still be good as a comparison to competitors.  We use the Gordon Growth Model, which assumes dividend will grow into perpetuity at a rate that can be sustained.  For a number of reasons a very conservative growth rate is used that cannot exceed that of a company's Gross Domestic Product (GDP). In this case we used the 5-year average of the 10-year government bond yield (2.6%). The expected dividend per share is then discounted to today's value at a cost of equity of 5.9%.  Relative to the current share price of US$55.4, the company appears   around fair value    at the time of writing.   The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent. Value Per Share = Expected Dividend Per Share / (Discount Rate - Perpetual Growth Rate)= US$1.7 / (5.9% – 2.6%)= US$52.7NasdaqGS:SJW Discounted Cash Flow November 22nd 2024  Important Assumptions  Now the most important 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 redoing the calculations yourself and playing with them.  The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance.  Given that we are looking at 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 accounts for debt.  In this calculation we've used 5.9%, which is based on a levered beta of 0.800. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.  SWOT Analysis for SJW GroupStrength  No major strengths identified for SJW.Weakness Earnings declined over the past year. Interest payments on debt are not well covered.Dividend is low compared to the top 25% of dividend payers in the Water Utilities market. Expensive based on P/E ratio and estimated fair value. Shareholders have been diluted in the past year.Opportunity Annual earnings are forecast to grow for the next 3 years. Have SJW insiders been buying lately? ThreatDebt is not well covered by operating cash flow. Paying a dividend but company has no free cash flows.  Annual earnings are forecast to grow slower than the American market. Is SJW well equipped to handle threats?  Looking Ahead:  Although the valuation of a company is important, it  is only one of many factors that you need to assess for a company.  The DCF model is not a perfect stock valuation tool.  Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued.  For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation.  For SJW Group, there are three  essential  aspects  you should assess:   Risks: Take risks, for example - SJW Group has   3 warning signs  (and 1 which is concerning)  we think you should know about.   Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SJW's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.  Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!   PS. The Simply Wall St app conducts 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.New: Manage All Your Stock Portfolios in One PlaceWe've created the ultimate portfolio companion for stock investors, and it's free.• Connect an unlimited number of Portfolios and see your total in one currency• Be alerted to new Warning Signs or Risks via email or mobile• Track the Fair Value of your stocksTry a Demo Portfolio for FreeHave feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. 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