Date: Mar 09,2020

From the three most important financial statements, Cash Flow is the most important one. For any well managed company, CASH IS KING. Numerous companies have gone bankrupt with strong balance sheets and sound income statements when they run out of cash.

What is Net Present Value (NPV)?

Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. NPV is used in capital budgeting and investment planning to analyze the profitability of a projected investment or project. At a higher level, it can be used to analyze a company as a whole and compare it with others as pure investments. This method requires tha analyst to make certain assumptions about the future, but the mathematics behind it can be automated.

Public company to evaluate:

Company Name: Apple Inc.

Company Ticker: AAPL

STEP 1. Pull Cashflow Statement from SEC

9/29/2019 9/29/2018 9/29/2017 9/29/2016
Operating.Cash.Flow $69,391,000 $77,434,000 $63,598,000 $65,824,000
Capital.Expenditure $10,495,000 $13,313,000 $12,795,000 $13,548,000
Free.Cash.Flow.1 $58,896,000 $64,121,000 $50,803,000 $52,276,000

STEP 2. Calculate Cash Flow Growth Year-Over Year

Now, we have to calculate the growth Year-Over-Year to give us an idea of how well the company manages its cash flows. We will use the average growth of the FCF (FCF Mean Growth) over the past years to forecast future Free Cash Flows. However, as we want to be very conservative, we will assume the following:

  1. If FCF Mean Growth is greather than 20%, then we will assume a 10% growth over the next 10 years
  2. If FCF Mean Growth is between 10 and 20%, then we will assume a 7% growth over the next 10 years
  3. If FCF Mean Growth is between 5 and 10%, then we will assume a 3% growth over the next 10 years
  4. If FCF Mean Growth is between 0 and 5%, then we will assume a 1% growth over the next 10 years
  5. In any other case we will suppose a flat growth

FCF Average Growth: 5.1%

FCF Growth to Forecast Cash Flows: 3%

And the projection of Free Cash Flows is:

2020 2021 2022 2023 2024 2025 2026 2027 2028 2029
AAPL $58,896,000 $60,662,880 $62,482,766 $64,357,249 $66,287,967 $68,276,606 $70,324,904 $72,434,651 $74,607,691 $76,845,921

STEP 3. Calculate Weighted Average Cost of Capital for each security

Calculate Betas

First, we need to calculate the Beta for the stock. The formula to calculate Beta is the following:

\(beta = covariance(Stock Monthly, MarketMonthly)/var(MarketMonthly)\)

So we follow these steps:

  1. Download the stock symbol historical pricing
  2. Calculate daily returns
  3. Download market symbol historical returns
  4. Calculate market’s returns
  5. Use Performance Analytics (CAPM.beta) to calculate Beta
This is the \(Beta\) for the stock:

1.29

Calculate Cost of Equity

The cost of equity for the stock is calculated using this formula:

\(Cost of Equity = RiskFreeRate/100 + Beta * (MarketRiskRate - RisfkFreeRate)/100\)

The cost of equity then is:

14%

STEP 4. Get Tax Rates, Equity and Debt from Balance Sheet and Income Statement

We need to estimate the effective tax rate paid by each company by using the actual Income Statements. You will be surprised that most companies do not pay the 35% rate many people believe they pay as they take advantage of tax loopholes.

We also get the Equity and Debt figures from the Balance Sheets. And the Free Market Rate using the Treasury Rates for 3 months. Many analysts use a longer rate here, a year or even longer. But I use 3 months as I consider you should rebalance your portfolios frequently.

If you don’t take care of your own money, no one will.

STEP 5. Calculate Weighted Average Cost of Capital (WACC) estimating a cost of debt of 8%.

To calculate the WACC we use this formula:

\(WACC = (equity/(equity+debt)*costofequity + (debt/(equity+debt)*Rd)*(1-taxes))\)

We estimate a cost of debt of 8% to simplify these calculation.

This is the WACC for the stock:

8.4%

STEP 6. Calculate the Net Present Value for each Stock using the WACC, the projected FCF and perpetual rate

The net present value will be divided by the number of outstanding shares to get an estimated price per share. Then, we pull directly from the Exchanges the latest trade and compare it to the estimated value to get a signal of BUY, SELL or HOLD

SYMBOL ESTIMATED PRICE ACTUAL PRICE ACTION FCF-MEAN-GROWTH % Growth used to project FCF %
2020-03-05 AAPL 172.1 270.88 SELL 5.08 3
LOW HIGH
2s (68%) 260.96 280.80
4s (95%) 251.05 290.71
6s (99.73%) 241.13 300.63