What Price Should You Be Buying FleetCor Technologies, Inc.’s (NYSE:FLT)?
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Choosing the right financial tool to evaluate a company can be a daunting task, especially when different models are giving you drastically different conclusions. A prime example of conflicts between valuation models is FleetCor Technologies, Inc.’s (NYSE:FLT). While my discounted cash flow (DCF) model tells me that it is overvalued by 18.89%, my relative valuation model says it is undervalued by 10.86%. Which model do I listen to and more importantly why?
View our latest analysis for FleetCor Technologies
Examining intrinsic valuation
Since forecasting future free cash flows (FCFs) accurately into the future is often difficult and a highly subjective task, I’ve used analysts’ FCF forecasts as a starting point for my DCF. For those less familiar with valuation, the assumption behind the DCF is that a firm’s intrinsic value is equal to the sum of all its future FCFs, which is why quality forecasts are a high priority. To obtain the per share intrinsic value of FLT, we must first discount the sum of FLT’s future FCFs by 12%, which gives us an equity value of $US$16b, then 85.85k shares outstanding are divided through. This results in an intrinsic value of $189.88. Take a look at how I arrived at this intrinsic value here.,
Before we move on, let’s evaluate whether this number is accurate. Since it is generally impossible to forecast FCFs indefinitely, it is common for analysts to forecast for an explicit forecast horizon and then assume the company is mature by the end of that period and in a stable growth phase. At 3.74%, FLT’s final year FCF growth is stable and sustainable. This check highlights that our model is currently using the correct forecast horizon for FLT, which solidifies the target price of our DCF.
A closer look at relative valuation
Unlike the DCF model, relative valuation is based on a different principle and therefore, has its own set of issues. The underlying assumption is that two companies with the same risk-return profiles should be priced identically. The hardest part; however, is finding companies that are similar to FLT. As such, I’ve used the IT industry as a proxy for FLT. The calculations for relative valuation are quite simple. By multiplying FLT’s earnings by the industry’s P/E ratio, we can obtain FLT’s fair value of $250.26, which tells us that it is currently undervalued. However, should we believe this result?
One quick way of finding out is to see if FLT shares a similar growth profile to the overall IT industry we are comparing it to. With a projected earnings growth rate of -0.74% for next year, FLT has a significantly different growth profile when compared with the IT industry, which is projected to grow at 15.46%. Unfortunately, this check shows that the IT industry is a poor proxy for FLT, which weakens our relative valuation analysis. Rather, selectively choosing companies that had similar growth characteristics to FLT would vastly improve our conclusion. I’d encourage you to do this by taking a look at FLT’s competitors.
What Model Should I Listen To?
Both are somewhat weakened by assumptions we have used to fill in the gaps. Relative valuation is computationally simple but exposed to market irrationality, which undermines its usefulness. Conversely, intrinsic valuation is immune from these factors but heavily affected by human forecasting errors. Given the pros and cons that I have laid out, I encourage you to derive a valuation by calculating a weighted average share price by using both models.
Next Steps:
For FLT, there are three important factors you should further examine:
Financial Health: Does FLT 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.
Future Earnings: How does FLT’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.
Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of FLT? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!
PS. The Simply Wall St app conducts a discounted cash flow for every stock on the NYSE every 6 hours. If you want to find the calculation for other stocks just search here.
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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
