Key Insights

Using the 2 Stage Free Cash Flow to Equity, W.W. Grainger fair value estimate is US$802 W.W. Grainger's US$1,037 share price signals that it might be 29% overvalued Our fair value estimate is 24% lower than W.W. Grainger's analyst price target of US$1,062

Does the May share price for W.W. Grainger, Inc. (NYSE:GWW) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by taking the forecast future cash flows of the company and discounting them back to today's value. This will be done using the Discounted Cash Flow (DCF) model. Models like these may appear beyond the comprehension of a lay person, but they're fairly easy to follow.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

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Is W.W. Grainger Fairly Valued?

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years of cash flows. 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, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) estimate

2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 Levered FCF ($, Millions)  US$1.66b US$1.80b US$1.92b US$2.10b US$2.08b US$2.08b US$2.10b US$2.13b US$2.17b US$2.22b Growth Rate Estimate Source Analyst x9 Analyst x9 Analyst x6 Analyst x2 Analyst x1 Est @ 0.12% Est @ 0.91% Est @ 1.46% Est @ 1.85% Est @ 2.12% Present Value ($, Millions) Discounted @ 7.3%  US$1.5k US$1.6k US$1.6k US$1.6k US$1.5k US$1.4k US$1.3k US$1.2k US$1.2k US$1.1k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$14b

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 2.8%. We discount the terminal cash flows to today's value at a cost of equity of 7.3%.

Terminal Value (TV)= FCF2034 × (1 + g) ÷ (r – g) = US$2.2b× (1 + 2.8%) ÷ (7.3%– 2.8%) = US$50b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$50b÷ ( 1 + 7.3%)10= US$25b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$39b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$1.0k, the company appears slightly overvalued at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.NYSE:GWW Discounted Cash Flow May 12th 2025

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the 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 W.W. Grainger 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 7.3%, which is based on a levered beta of 1.051. 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.

View our latest analysis for W.W. Grainger

SWOT Analysis for W.W. Grainger

Strength

Earnings growth over the past year exceeded the industry.

Debt is well covered by earnings and cashflows.

Dividends are covered by earnings and cash flows.

Weakness

Earnings growth over the past year is below its 5-year average.

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

Expensive based on P/E ratio and estimated fair value.

Opportunity

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

Threat

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

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Can we work out why the company is trading at a premium to intrinsic value? For W.W. Grainger, we've compiled three essential factors you should consider:

Risks: Be aware that  W.W. Grainger is showing  2 warning signs in our investment analysis, you should know about... Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for GWW's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors. 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 NYSE every day. If you want to find the calculation for other stocks just search here.

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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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