Using the 2 Stage Free Cash Flow to Equity, O’Reilly Automotive fair value estimate is US$1,167.
Current share price of US$1,210 suggests O’Reilly Automotive is potentially trading close to its fair value.
Analyst price target for ORLY is US$1,272, which is 9.0% above our fair value estimate.
Today we will run through one way of estimating the intrinsic value of O’Reilly Automotive, Inc. (NASDAQ:ORLY) by taking the expected future cash flows and discounting them to today’s value. We will use the Discounted Cash Flow (DCF) model on this occasion. Before you think you won’t be able to understand it, just read on! It’s actually much less complex than you’d imagine.
Remember though, that there are many ways to estimate a company’s value, and a DCF is just one method. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.
View our latest analysis for O’Reilly Automotive.
The Discounted Cash Flow Model
The DCF model calculates the present value of future cash flows using a discount rate that represents the time value of money. The most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows.
If you don’t agree with these result, have a go at the calculation yourself and play with the 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 O’Reilly Automotive 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 7.0%, which is based on a levered beta of 1.058.
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.
Important Assumptions
- Discount rate: 7.0%
- Levered beta: 1.058
- Industry average beta: 1.06
These assumptions are crucial to the calculation, so feel free to experiment with different values and see how it affects the result.
SWOT Analysis for O’Reilly Automotive
The SWOT analysis provides a framework for understanding the company’s strengths, weaknesses, opportunities, and threats.
Strengths:
- Earnings growth over the past year exceeded the industry.
- Debt is well covered by earnings and cashflows.
Weaknesses:
- Earnings growth over the past year is below its 5-year average.
- Expensive based on P/E ratio and estimated fair value.
Opportunities:
- Annual earnings are forecast to grow for the next 4 years.
Threats:
- Total liabilities exceed total assets, which raises the risk of financial distress.
- Annual earnings are forecast to grow slower than the American market.
Moving On: Valuation is Only One Side of the Coin
Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. It’s not possible to obtain a foolproof valuation with a DCF model.
Preferably you’d apply different cases and assumptions and see how they would impact the company’s valuation. For example, changes in the company’s cost of equity or the risk free rate can significantly impact the valuation.
Risks: 3 Warning Signs for O’Reilly Automotive
We’ve discovered three warning signs for O’Reilly Automotive that you should be aware of before investing here:
- High debt: Total liabilities exceed total assets, which raises the risk of financial distress.
- Expensive valuation: The company’s P/E ratio and estimated fair value are higher than the industry average.
- Uncertainty in future growth: Annual earnings are forecast to grow slower than the American market.
Management: Insider Buying and Selling
Have insiders been ramping up their shares to take advantage of the market’s sentiment for ORLY’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
Other Solid Businesses: Exploring Interactive Lists
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!