A Look At The Intrinsic Value Of ITT Inc. (NYSE:ITT)

ITT, Inc. +0.76% Post

ITT, Inc.

ITT

137.57

137.57

+0.76%

0.00% Post

Key Insights

  • ITT's estimated fair value is US$168 based on 2 Stage Free Cash Flow to Equity
  • ITT's US$137 share price indicates it is trading at similar levels as its fair value estimate
  • Analyst price target for ITT is US$139 which is 17% below our fair value estimate

Does the March share price for ITT Inc. (NYSE:ITT) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the expected future cash flows and discounting them to their present value. One way to achieve this is by employing the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

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 ITT

Is ITT Fairly Valued?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. 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 companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF ($, Millions) US$462.8m US$515.6m US$577.7m US$641.2m US$688.7m US$729.1m US$764.1m US$795.0m US$823.0m US$848.9m
Growth Rate Estimate Source Analyst x5 Analyst x5 Analyst x2 Analyst x1 Est @ 7.41% Est @ 5.87% Est @ 4.80% Est @ 4.04% Est @ 3.52% Est @ 3.15%
Present Value ($, Millions) Discounted @ 7.1% US$432 US$450 US$471 US$488 US$489 US$484 US$474 US$460 US$445 US$429

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$4.6b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.3%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 7.1%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$849m× (1 + 2.3%) ÷ (7.1%– 2.3%) = US$18b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$18b÷ ( 1 + 7.1%)10= US$9.2b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$14b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$137, the company appears about fair value at a 19% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
NYSE:ITT Discounted Cash Flow March 28th 2024

Important Assumptions

Now 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 evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. 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 ITT 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 7.1%, which is based on a levered beta of 1.039. 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 ITT

Strength
  • Earnings growth over the past year exceeded its 5-year average.
  • Debt is not viewed as a risk.
  • Dividends are covered by earnings and cash flows.
Weakness
  • Earnings growth over the past year underperformed the Machinery industry.
  • Dividend is low compared to the top 25% of dividend payers in the Machinery market.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
  • Current share price is below our estimate of fair value.
Threat
  • Annual earnings are forecast to grow slower than the American market.

Next Steps:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For ITT, there are three additional elements you should assess:

  1. Financial Health: Does ITT have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Future Earnings: How does ITT's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  3. 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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

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