Key ideas
- The projected fair value for Rockwell Automation is $325 based on a 2-stage free cash flow to equity
- Rockwell Automation’s stock price of $277 indicates it is trading at levels similar to its fair value estimate
- The analysts’ price target for ROK is $286, 12% below our fair value estimate.
How does Rockwell Automation, Inc. (NYSE:ROK) compare to its intrinsic value? Using the most recent financial data, we’ll examine whether the stock is fairly priced by projecting its future cash flows and then discounting them to today’s value. We’ll use the discounted cash flow (DCF) model to do this. It may sound complicated, but it’s actually quite simple!
Keep in mind, though, that there are many ways to estimate the value of a business, and cash flow analysis is just one method. For those who are fans of equity analysis, the Simply Wall St analysis model presented here may be of interest.
Check out our latest analysis for Rockwell Automation
Analyzing the numbers
We will use a two-stage DCF model, which, as the name suggests, considers two stages of growth. The first stage is typically a period of higher growth that levels off towards the terminal value, captured in the second period of “steady growth”. In the first stage, we need to estimate the company’s cash flows over the next ten years. Where possible, we use analyst estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with shrinking free cash flow will slow their rate of contraction and that companies with growing free cash flow will see their growth rate slow over this period. We do this to reflect the fact that growth tends to slow more in the early years than in later years.
In general, we assume that a dollar today is worth more than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at an estimate of the present value:
10-year free cash flow (FCF) forecast
| 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | |
| Leveraged FCF ($ millions) | 1.39 billion US dollars | 1.55 billion US dollars | 1.90 billion US dollars | 2.04 billion US dollars | 2.14 billion US dollars | 2.23 billion US dollars | 2.32 billion US dollars | 2.40 billion US dollars | 2.47 billion US dollars | 2.54 billion US dollars |
| Source of growth rate estimation | Analyst x13 | Analyst x6 | Analyst x3 | Analyst x1 | Estimated at 5.22% | Estimated at 4.37% | Estimated at 3.77% | Estimated at 3.36% | Estimated at 3.06% | Estimated at 2.86% |
| Present value (in millions of dollars) discounted at 7.7% | $1.3k US | $1.3k US | $1.5k US | $1.5k US | $1.5k US | $1.4k US | $1.4k US | $1.3k US | $1.3k US | $1.2k US |
(“Est” = FCF growth rate estimated by Simply Wall St)
Present value of cash flows over 10 years (PVCF) = 14 billion US dollars
We now need to calculate the terminal value, which takes into account all future cash flows after this ten-year period. The Gordon growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield, or 2.4%. We discount the terminal cash flows to present value at a cost of equity of 7.7%.
Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = $2.5 billion × (1 + 2.4%) ÷ (7.7% – 2.4%) = $49 billion
Present value of terminal value (PVTV)= Tele / (1 + r)ten= 49 billion US dollars ÷ (1 + 7.7%)ten= 23 billion US dollars
The total value is the sum of the cash flows for the next ten years plus the discounted terminal value, which gives the total value of equity, which in this case is US$37 billion. In the last step, we divide the value of equity by the number of shares outstanding. Relative to the current share price of US$277, the company appears to be roughly fairly valued at a 15% discount to the current share price. Valuations are imprecise instruments, however, much like a telescope: if you move a few degrees, you end up in a different galaxy. Keep that in mind.
Important assumptions
The calculation above relies heavily on two assumptions. The first is the discount rate and the other is cash flow. Part of investing is making your own assessment of a company’s future performance, so try the calculation yourself and check your own assumptions. DCF also doesn’t take into account the possible cyclicality of an industry or a company’s future capital needs, so it doesn’t give a complete picture of a company’s potential performance. Since we’re looking at Rockwell Automation 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 into account debt. In this calculation, we used 7.7%, which is based on a leveraged beta of 1.156. Beta is a measure of a stock’s volatility, relative to the market as a whole. We derive our beta from the industry average beta of comparable companies globally, with a limit imposed between 0.8 and 2.0, which is a reasonable range for a stable company.
SWOT Analysis for Rockwell Automation
- Debt is well covered by earnings and cash flow.
- Dividends are covered by profits and cash flow.
- Revenues have declined over the past year.
- The dividend is low compared to the top 25% of dividend payers in the electricity market.
- Annual revenues are expected to increase over the next three years.
- The current stock price is below our estimate of fair value.
- Annual profits are expected to grow more slowly than the U.S. market.
Go forward :
Valuation is just one aspect of building your investment thesis, and ideally, it won’t be the only piece of analysis you look at for a company. The DCF model isn’t a perfect stock valuation tool. It’s best to run different scenarios and assumptions and see how they might affect the company’s valuation. For example, if the terminal value growth rate is adjusted slightly, it can significantly change the overall result. For Rockwell Automation, we’ve put together three key areas you should consider in more detail:
- Risks: Know that Rockwell Automation shows 1 warning sign in our investment analysis you should know about…
- Future benefits:How does ROK’s growth rate compare to its peers and the broader market? Explore the analyst consensus for the coming years in detail by interacting with our free analyst growth expectations chart.
- Other high quality alternatives:Do you like good all-rounders? Explore our interactive list of high-quality stocks to get an idea of what you might be missing!
PS. The Simply Wall St app performs an updated cash flow valuation for every NYSE stock every day. If you want to find the calculation for other stocks, just search here.
New: AI Action Analyzer and Alerts
Our new AI Stock Screener analyzes the market every day to uncover opportunities.
• Dividend powers (yields of 3% and above)
• Small caps undervalued with insider buying
• High-growth technology and AI companies
Or create your own from over 50 measurements.
Explore now for free
Do you have any comments on this article? Are you concerned about its content? Get in touch with us directly. You can also send an email to editorial-team (at) simplywallst.com.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to constitute financial advice. This is not a recommendation to buy or sell any stock, and does not take into account your objectives or financial situation. Our goal is to provide you with focused, long-term analysis based on fundamental data. Please note that our analysis may not factor in the latest price-sensitive company announcements or qualitative information. Simply Wall St has no position in any of the stocks mentioned.
Do you have any comments on this article? Are you concerned about its content? Contact us directly. You can also send an email to [email protected]
