Motorola Solutions, Inc. (NYSE: MSI) is a major player in the global security and communication sector. But how far is the company from its true worth? In order to evaluate this, we'll dive into the financial data to assess whether the stock is priced fairly. To do this, we’ll employ a widely-used tool: the Discounted Cash Flow (DCF) model. This method may seem complex, but I’ll break it down for you step-by-step, using an easy-to-follow example.
The DCF model allows us to estimate the intrinsic value of a company by projecting its future cash flows and then adjusting them to their current value. It's important to note that there are several ways to estimate a company’s value, and the DCF is just one of them. If you're still unsure about this valuation approach, feel free to check out Simply Wall St’s detailed analysis model.
Two-Stage Growth Model
For this analysis, we’re using a two-stage growth model. This approach splits the company’s growth into two phases: an initial high-growth period, followed by a more stable, slower growth phase.
In the first stage, we focus on estimating Motorola Solutions’ free cash flow (FCF) for the next ten years. When available, we use analyst estimates. In cases where estimates aren’t provided, we extrapolate from the previous year’s cash flow data. The assumption here is that companies with shrinking cash flow will experience a deceleration in that shrinkage, while those with growing cash flow will see growth slow over time.
Present Value of Future Cash Flows
The key idea behind the DCF model is that a dollar in the future is worth less than a dollar today. Therefore, we discount future cash flows to reflect their present value. For example, according to Simply Wall St’s estimates, the present value of Motorola Solutions' cash flow over the first ten years is $22 billion.
Calculating Terminal Value
Next, we calculate the Terminal Value (TV), which represents all future cash flows beyond the first ten years. We use the Gordon Growth formula to calculate this value, assuming a growth rate equal to the 5-year average of the 10-year government bond yield of 2.8%. To bring the future terminal cash flows to today’s value, we apply a discount rate of 7.1%.
By plugging in the numbers: [ TV = FCF2034 \times \left( \frac{(1 + g)}{(r - g)} \right) = 3.9 , \text{billion} \times \left( \frac{(1 + 2.8%)}{(7.1% - 2.8%)} \right) = 93 , \text{billion} ] Now, we discount the terminal value: [ PVTV = \frac{TV}{(1 + r)^{10}} = \frac{93 , \text{billion}}{(1 + 7.1%)^{10}} = 47 , \text{billion} ]
Final Valuation
The total value of the company, or its equity value, is the sum of the present value of the cash flows and the terminal value, which in this case amounts to $69 billion. To calculate the intrinsic value per share, we divide this total by the number of outstanding shares. At the time of writing, the stock price of Motorola Solutions stands at $426, suggesting that the company is fairly valued.
Sensitivity of the DCF Model
It’s important to note that this calculation is highly sensitive to two key assumptions: the discount rate and the projected cash flows. You may not agree with these assumptions, and that's perfectly fine—if you're curious, you can even adjust these inputs yourself to see how they impact the valuation. Additionally, the DCF model doesn’t account for industry cyclicality or future capital needs, so it’s only one piece of the puzzle.
For Motorola Solutions, we’ve used a cost of equity discount rate of 7.1%, which reflects the company’s beta of 1.004. Beta measures stock volatility compared to the market, and in this case, we’ve relied on the average beta for companies in similar industries. A stable business typically has a beta in the range of 0.8 to 2.0.
Considerations Beyond the DCF
Although the DCF is a helpful tool for estimating the intrinsic value of Motorola Solutions, it’s just one part of a larger analysis. The model is not perfect and should be viewed as a guide to understanding the assumptions that need to be true for the stock to be undervalued or overvalued. For instance, small changes in the terminal growth rate can significantly affect the outcome.
Motorola Solutions has other factors worth exploring. While the DCF model provides a solid starting point, investors should also take into account the company’s strategic direction, market conditions, and long-term goals.
Simply Wall St updates its DCF calculations for American stocks daily. If you want to explore the intrinsic value of other companies, simply search on their platform.
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