Key Insights

• CenterPoint Energy's estimated fair value is US$24.36 based on Dividend Discount Model

• CenterPoint Energy's US$30.84 share price signals that it might be 27% overvalued

• The US$31.01 analyst price target for CNP is 27% more than our estimate of fair value

Does the June share price for CenterPoint Energy, Inc. (NYSE:CNP) reflect what it's really worth? Today, we will estimate the stock's intrinsic value  by projecting its future cash flows and then discounting them to today's value.  The Discounted Cash Flow (DCF) model is the tool we will apply to do this.  There's really not all that much to it, even though it might appear quite complex.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method.  If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Step By Step Through The Calculation

As CenterPoint Energy operates in the integrated utilities sector, we need to calculate the intrinsic value slightly differently.  In this approach dividends per share (DPS) are used, as free cash flow is difficult to estimate and often not reported by analysts.  Unless a company pays out the majority of its FCF as a dividend, this method will typically underestimate the value of the stock.  We use the Gordon Growth Model, which assumes dividend will grow into perpetuity at a rate that can be sustained.  The dividend is expected to grow at an annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.4%. We then discount this figure to today's value at a cost of equity of 6.1%.  Compared to the current share price of US$30.8, 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.

Value Per Share = Expected Dividend Per Share / (Discount Rate - Perpetual Growth Rate)

= US$0.9 / (6.1% – 2.4%)

= US$24.4

NYSE:CNP Discounted Cash Flow June 5th 2024

Important Assumptions

We would point out that 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 CenterPoint Energy 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 6.1%, which is based on a levered beta of 0.800. 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.

SWOT Analysis for CenterPoint Energy

Strength

• Earnings growth over the past year exceeded the industry.

• See CNP's revenue and earnings trends.

Weakness

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

• Interest payments on debt are not well covered.

• Dividend is low compared to the top 25% of dividend payers in the Integrated Utilities market.

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

Opportunity

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

Threat

• Debt is not well covered by operating cash flow.

• Paying a dividend but company has no free cash flows.

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

• Is CNP well equipped to handle threats?

Next Steps:

Whilst important, the DCF calculation  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.   Why is the intrinsic value lower than the current share price?   For CenterPoint Energy, there are three  important  elements  you should look at:

1. Risks: As an example, we've found 2 warning signs for CenterPoint Energy (1 can't be ignored!) that you need to consider before investing here.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for CNP's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock 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.