Ford (F) stock has been the star of our portfolio ever since we brought it into our portfolio at an above-average weighting. It is still the biggest position in our portfolio. For our investment thesis in Ford (F), we often simply argue that in the near term, the stock deserves to trade at a 10x forward P/E multiple, and given a 1.9$ EPS estimated for 2022, F deserves to trade at 19$/share this year; and then given a 2.6$ EPS estimated for 2023, F should trade to 26$ during 2022. Part of our argument also includes a higher multiple (greater than 10) in the long term when the company is able to integrate battery and software services into its revenue. 

We argued this when we initiated the position earlier this year in the low teens, and have enjoyed a ~40% gain in this position as the stock has ran up 6 points from our average cost basis. However, since Ford (F) is such a big position in our portfolio, we want to have something more than just EPS multiple estimates to back up our strong conviction in this name. In other words, we want to have a big, long-term position in Ford (F), and we need to have strong reasons. In today's post, we are looking at Ford (F) through an intrinsic valuation method.

Discounted Cash Flow (DCF)

Discounted Cash Flow (DCF) is the most widely-accepted method to calculate the fair value of a company. The premise here is that the fair value of a company is the total value of its incoming cash (cash flow), subtracting its expenses, and then discount it to today's value. There are many variations of DCF that can be used depending on the particular company being applied to. For Ford (F), we are going to use the 2-Stage Discounted Cash Flow Model, generally suitable for companies that do not necessarily grow at constant rate over time. Other DCF models such as Dividend Discount Model, Excess Returns Model, and Adjusted-Funds-From-Operations Model are all inappropriate for Ford.   

The 2-Stage DCF, as the name suggests, takes into account 2 stages of growth: high-growth and stable-growth. The first stage is the high-growth period, calculated using estimates over the next ten years of levered free cash flow to equity, which is either sourced from analyst or estimated using extrapolated historical annual growth rate. The end stage is the stable-growth period, in which the company reaches terminal growth. A terminal value is calculated using the Gordon Growth formula, with an assumption that the company will continue to grow its earnings at the 10-year Treasury Yield, forever. Since a DCF is all about the idea that a dollar in the future is less valuable than a dollar today, we will need to discount the value of these future cash flows to their estimated value in today's dollars. To obtain a fair value share price, we divide the calculated present value by the number of available shares, giving a fair value per share.

Let's Work Through The Calculation

First we need to obtain either analysts' estimates for future FCF, or try to estimate ourselves based on assumed growth rates that decline in the later years.

Then we try to discount those future FCF to 2021's value using a discount rate.

Discount rate = Cost of equity = Risk Free Rate + (Beta * Equity Risk Premium) = 2% + (2.0 * 4.7%) = 11.4%

Present Value of 10-Year Cash Flow (PVCF) = $66.4 Billion

After calculating the present value of future cash flows in the initial 10-year high growth period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first high growth period. For this, a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case, we use the 5-year average of the 10-Year Treasury Yield which is 2%. In the same way as with the 10-year high growth period, we discount future cash flows to today's value, using a cost of equity of 11%.

Terminal Value (TV) = FCF 2031 x (1 + g) : (r - g) = $15.1 Billion x (1 + 2.0%) : (11% - 2.0%) = $175 Billion

Present Value of Terminal Value (PVTV) = TV / (1 + r)^10 = $175 Billion : (1 + 11%)^10 = $63 Billion 

We have calculated the present values of 2 stages, the initial high-growth stage and the terminal stage. We now can determine the total equity value, which is the sum of the present values of the 2 stages.

Total Equity Value = Present Value of 10-Year Cash Flow + Present Value of Terminal Value = $66.4 Billion + $63 Billion = $129.4 Billion 

The last step is to divide the equity value by the number of shares outstanding. 

Fair Value = Total Equity Value / Number of Shares Outstanding = $129.4 Billion / 4.00 Billion Shares = $32.3/Share

Results: Using the two-stage Discounted Cash Flow (DCF) Model, we have calculated the fair value of Ford (F) stock to be $32.3/share. With today's share price of roughly $20.0/share, our model shows the stock is 38% undervalued compared to the modelled fair value of the company. The stock moving towards our modelled fair value of the company would imply a 61.5% gain in the stock value. 

Bottom Line:

DCF is a model, and just that. There are so many assumptions used which alternate on a day-to-day basis (for example, the 10-Year Treasury Yield is currently only at 1.4%, but we used 2%). We're not going to use $32.3/share as our price target for Ford (F), however, it is great to see that a valuation model could back up our investment thesis in this stock.

The electric vehicle sector is a secular one that only grows from here, therefore investing in this sector makes sense. However, choosing which company to invest in is a difficult choice. It's not a surprise to anyone that this sector will be the future, so a lot of stocks within this sector is trading at a very high premium. Tesla (TSLA) is trading at 100x next year's earnings, compared to the 20x multiple of the S&P 500. Rivian (RIVN) and Lucid (LCID) are EV companies with no sales yet but their market caps are already near $100 billion. 

But there is Ford (F) with only a $80 billion market cap. Ford has been in the EV market and will continue to penetrate with the electrification of America's best-selling products (Electric Mustang, Electric F-150 pickup truck, Electric Transit van). It sells hundreds of thousands of cars a year, bringing in billions of dollars, and returning 2% dividend to shareholders. It only trades at a 10x forward multiple. Today's DCF calculation shows it's undervalued by 38%. What we see in Ford (F) is a cheap stock of a strong company.