Key Insights

Using the 2 Stage Free Cash Flow to Equity, Smiths Group fair value estimate is UK£31.85 Current share price of UK£22.18 suggests Smiths Group is potentially 30% undervalued Analyst price target for SMIN is UK£23.48 which is 26% below our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Smiths Group plc (LON:SMIN) as an investment opportunity by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Before you think you won't be able to understand it, just read on! It's actually much less complex than you'd imagine.

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. Anyone interested in learning a bit more about intrinsic value should have a read of the Simply Wall St analysis model.

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Crunching The Numbers

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 Levered FCF (£, Millions)  UK£302.6m UK£344.5m UK£396.5m UK£422.0m UK£523.0m UK£575.7m UK£620.7m UK£659.4m UK£693.2m UK£723.3m Growth Rate Estimate Source Analyst x6 Analyst x7 Analyst x7 Analyst x1 Analyst x1 Est @ 10.08% Est @ 7.82% Est @ 6.23% Est @ 5.13% Est @ 4.35% Present Value (£, Millions) Discounted @ 7.6%  UK£281 UK£298 UK£319 UK£315 UK£363 UK£372 UK£373 UK£368 UK£360 UK£349

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£3.4b

Story Continues

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.5%. We discount the terminal cash flows to today's value at a cost of equity of 7.6%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = UK£723m× (1 + 2.5%) ÷ (7.6%– 2.5%) = UK£15b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£15b÷ ( 1 + 7.6%)10= UK£7.1b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£11b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of UK£22.2, the company appears quite good value at a 30% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.LSE:SMIN Discounted Cash Flow June 27th 2025

The Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 Smiths Group 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 7.6%, which is based on a levered beta of 0.979. 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.

Check out our latest analysis for Smiths Group

SWOT Analysis for Smiths Group

Strength

Earnings growth over the past year exceeded the industry.

Debt is not viewed as a risk.

Dividends are covered by earnings and cash flows.

Weakness

Dividend is low compared to the top 25% of dividend payers in the Industrials market.

Opportunity

Annual earnings are forecast to grow for the next 3 years.

Trading below our estimate of fair value by more than 20%.

Threat

Annual earnings are forecast to grow slower than the British market.

Next Steps:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Smiths Group, we've compiled three essential factors you should assess:

Financial Health: Does SMIN 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 SMIN'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 Solid Businesses: 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!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the LSE every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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