Trump's tax law sent stocks soaring — but now his trade war is hurting the market's biggest driver, and threatening to erase all his progress -Business Insider.

Trump's tax law sent stocks soaring — but now his trade war is hurting the market's biggest driver, and threatening to erase all his progress  As investors look ahead to 2019 earnings, they're becoming more worried about the impact of US trade policy on profit growth.  This had a limited effect on the stock market until recently, when many companies started detailing how badly they expect tariffs to hurt their bottom lines.  The trade war worsened a sell-off that wiped the stock market's gains for 2018, and now threatens to undo the positive effects of tax cuts.  President Donald Trump rarely brags about the stock market on Twitter these days.  He has instead turned to other issues during the market's sharp correction — one that's wiped out gains for the year just weeks before the crucial midterm elections. Earlier in 2018, when it seemed like stocks were hitting all-time highs on an almost daily basis, Wall Street was quick to cite the Tax Cuts and Jobs Act as a significant catalyst of future profit growth, which has been the most important driver of stock prices. UBS, for example, forecast last December that profit gains would lift the S&P 500 by 25% this year if the tax bill passed. Other firms devised investing playbooks for tax reform, such as buying companies that had been paying the highest rates, and loading up on multinationals with piles of overseas profits waiting to be repatriated. However, in October, US stocks fully joined a global sell-off that's now on pace to erase nearly $8 trillion in market cap, the biggest monthly decline since the 2008 financial crisis according to Bloomberg data. It certainly seems that investors who were once quick to praise the merits of one of Trump's signature policies (tax reform), have started focusing more on the risks from another (tariffs). This can be seen in the outlook for 2019 earnings, which has seen trade shift from a dormant concern to a prominent one. "We estimate that an all-out US-China trade war (25% tariff on US-China trade) would reduce S&P 500 earnings ~3%," Barclays' Ajay Rajadhyaksha said in a recent note. "One potential reason why the market was sanguine about trade wars was that this is not a meaningful fraction of 2018 earnings growth, which is estimated to be greater than 20%." Rajadhyaksha said he expects less than 10% growth next year. The idea that mounting trade tensions could lead to a profit slowdown has been a major recurring theme of third-quarter earnings season. Ford, Honda, and BMW all issued warnings about how the steel and aluminum tariffs are raising costs and biting into profits.  Companies in the industrials sector that rely on access to Chinese markets have also sounded the alarm on tariffs. Caterpillar sank when it said tariffs would raise its material costs, even though its executives tried to reassure investors that it planned to put offsets in place.   Fastenal, a supplier of nuts, bolts, and other fasteners, said on its earnings call that it took a limited hit from US tariffs on China until the third round announced mid-September that impacted its North American customers.   Other examples abound; according to FactSet, more than a third of companies discussed tariffs on their earnings calls. With all of that considered, it would seem the stock market's wipeout this month has shown that the trade war is worsening a sell-off that was brewing all along.  But trade has by no means been the only issue on investors' minds of late. Fed policy — and its impact on inflation and borrowing costs — has been troubling investors since the correction earlier this year. Trump touched upon the subject on Tuesday when, on Twitter, he quoted Wells Fargo strategist Scott Wren as saying the S&P 500 would be higher if the Federal Reserve "backs off and starts talking a little more dovish."  Trump has gone as far as to call the Fed "crazy" for raising interest rates and thereby reducing the allure of borrowing. The slowdown in cyclical sectors like housing and autos holds evidence of the effect of higher rates. Beyond the trade war's impact on corporate earnings, as well as the Fed's planned rate hikes, investors are grappling with what's ahead for the market. At this point, if just one thing is abundantly clear, it's that Trump's conflict with China is doing more harm than good. Read » Advertisement   Also On Markets Today:      Email sent to:   ericauseemeng@gmail.com   |   Manage your email preferences   |   Unsubscribe  Terms of Service   |   Privacy Policy 150 Fifth Avenue, 8th Floor New York, NY 10011

Calculating The Intrinsic Value Of Magna International Inc (TSE:MG)

Simply Wall St.October 29, 2018

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I am going to run you through how I calculated the intrinsic value of Magna International Inc (TSE:MG) by taking the foreast future cash flows of the company and discounting them back to today’s value. I will use the discounted cash flows (DCF) model. It may sound complicated, but actually it is quite simple! If you want to learn more about discounted cash flow, the basis for my calcs can be read in detail in the Simply Wall St analysis model. If you are reading this and its not October 2018 then I highly recommend you check out the latest calculation for Magna International by following the link below.

View our latest analysis for Magna International

What’s the value?

I use what is known as a 2-stage model, which simply means we have two different periods of varying growth rates for the company’s cash flows. Generally the first stage is higher growth, and the second stage is a more stable growth phase. In the first stage we need to estimate the cash flows to the business over the next five years. For this I used the consensus of the analysts covering the stock, as you can see below. I then discount the sum of these cash flows to arrive at a present value estimate.

5-year cash flow estimate

	2019	2020	2021	2022	2023
Levered FCF ($, Millions)	$1.81k	$2.03k	$2.10k	$2.18k	$2.25k
Source	Analyst x4	Analyst x3	Est @ 3.48%	Est @ 3.48%	Est @ 3.48%
Present Value Discounted @ 12.71%	$1.61k	$1.60k	$1.47k	$1.35k	$1.24k

Present Value of 5-year Cash Flow (PVCF)= US$7.3b

After calculating the present value of future cash flows in the intial 5-year period we need to calculate the Terminal Value, which accounts for all the future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at an annual growth rate equal to the 10-year government bond rate of 2.3%. We discount this to today’s value at a cost of equity of 12.7%.

Terminal Value (TV) = FCF2022 × (1 + g) ÷ (r – g) = US$2.3b × (1 + 2.3%) ÷ (12.7% – 2.3%) = US$22.2b

Present Value of Terminal Value (PVTV) = TV / (1 + r)5 = US$22.2b ÷ ( 1 + 12.7%)5 = US$12.2b

The total value is the sum of cash flows for the next five years and the discounted terminal value, which results in the Total Equity Value, which in this case is US$19.5b. In the final step we divide the equity value by the number of shares outstanding. If the stock is an depositary receipt (represents a specified number of shares in a foreign corporation) or ADR then we use the equivalent number. This results in an intrinsic value in the company’s reported currency of $57.78. However, MG’s primary listing is in Canada, and 1 share of MG in USD represents 1.311 ( USD/ CAD) share of NYSE:MGA, so the intrinsic value per share in CAD is CA$75.74. Compared to the current share price of CA$63.3, the stock is about right, perhaps slightly undervalued at a 16% discount to what it is available for right now.

TSX:MG Intrinsic Value Export October 29th 18

The assumptions

Now 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 my result, have a go at the calculation yourself and play with the assumptions. Because we are looking at Magna International as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighed average cost of capital, WACC) which accounts for debt. In this calculation I’ve used 12.7%, which is based on a levered beta of 1.353. This is derived from the Bottom-Up Beta method based on comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

Next Steps:

Whilst important, DCF calculation shouldn’t be the only metric you look at when researching a company. For MG, I’ve compiled three important factors you should further research:

1. Financial Health: Does MG 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.
2. Future Earnings: How does MG’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.
3. Other High Quality Alternatives: Are there other high quality stocks you could be holding instead of MG? 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 TSE every 6 hours. If you want to find the calculation for other stocks just search here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.