Fair value estimate from Gartner, Inc. (NYSE: IT)
Does July’s Gartner, Inc. (NYSE: IT) Stock Price Reflect What It’s Really Worth? Today we are going to estimate the intrinsic value of the stock by estimating the future cash flows of the company and discounting them to their present value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don’t be put off by the jargon, the underlying calculations are actually quite simple.
Businesses can be valued in many ways, which is why we emphasize that a DCF is not perfect for all situations. If you want to know more about discounted cash flow, the rationale for this calculation can be read in detail in the Simply Wall St analysis template.
Discover our latest analysis for Gartner
Is Gartner correctly valued?
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”. In the first step, we need to estimate the company’s cash flow over 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) | $986.1 million | $1.18 billion | $1.19 billion | $1.20 billion | $1.22 billion | $1.24 billion | $1.26 billion | $1.28 billion | $1.30 billion | $1.32 billion |
Growth rate estimate Source | Analyst x2 | Analyst x1 | Is at 0.61% | Is at 1.01% | Is at 1.29% | Is at 1.48% | Is at 1.62% | Is at 1.72% | Is at 1.78% | Is at 1.83% |
Present value (in millions of dollars) discounted at 6.5% | $926 | $1,000 | $985 | $934 | $889 | $847 | $808 | $771 | $737 | $705 |
(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = $8.6 billion
We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (1.9%) to estimate future growth. Similar to the 10-year “growth” period, we discount future cash flows to present value, using a cost of equity of 6.5%.
Terminal value (TV)= FCF_{2032} × (1 + g) ÷ (r – g) = $1.3 billion × (1 + 1.9%) ÷ (6.5%–1.9%) = $30 billion
Present value of terminal value (PVTV)= TV / (1 + r)^{ten}= $30 billion ÷ (1 + 6.5%)^{ten}= $16 billion
The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is $24 billion. In the last step, we divide the equity value by the number of shares outstanding. Compared to the current share price of $243, the company appears to be about fair value at a 20% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.
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 entries, I recommend that you redo the calculations yourself and play around with them. 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 consider Gartner 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 6.5%, which is based on a leveraged beta of 1.079. 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.
Next steps:
Although a business valuation is important, it is only one of many factors you need to assess for a business. It is not possible to obtain an infallible valuation with a DCF model. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. If a company grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output may be very different. For Gartner, we’ve rounded up three essentials you should dig into:
- Risks: For example, we have identified 4 warning signs for Gartner (1 is a little worrying) you should be aware.
- Future earnings: How does the growth rate of IT compare to its peers and the broader market? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
- 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.
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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.