If You Bought Provident Financial plc (LON:PFG) Today, There May Be An Upside
One of the most difficult industry to value is consumer finance, given that they adhere to different rules compared to other companies. These lenders, for example, must hold certain levels of capital in order to maintain a safe cash cushion. Looking at data points such as book values, on top of the return and cost of equity, may be practical for calculating PFG’s true value. Below I’ll look at how to value PFG in a reasonably useful and uncomplicated approach. Check out our latest analysis for Provident Financial
Why Excess Return Model?
Two main things that set financial stocks apart from the rest are regulation and asset composition. United Kingdom’s financial regulatory environment is relatively strict. Furthermore, consumer financials generally don’t hold significant portions of tangible assets as part of total assets. Excess Returns overcome some of these issues. Firstly, it doesn’t focus on factors such as capex and depreciation – relevant for tangible asset firms – but rather emphasize forecasting stable earnings and book values.
How Does It Work?
The main assumption for this model is that equity value is how much the firm can earn, over and above its cost of equity, given the level of equity it has in the company at the moment. The returns in excess of cost of equity is called excess returns:
Excess Return Per Share = (Stable Return On Equity – Cost Of Equity) (Book Value Of Equity Per Share)
= (21.59% – 8.30%) * £6.5 = £0.86
We use this value to calculate the terminal value of the company, which is how much we expect the company to continue to earn every year, forever. This is a common component of discounted cash flow models:
Terminal Value Per Share = Excess Return Per Share / (Cost of Equity – Expected Growth Rate)
= £0.86 / (8.30% – 1.49%) = £12.7
Combining these components gives us PFG’s intrinsic value per share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= £6.5 + £12.7 = £19.2
Relative to the present share price of £8.04, PFG is , at this time, priced below its intrinsic value. This means you can buy PFG at a discount to its value of £19.2. Pricing is one part of the analysis of your potential investment in PFG. There are other important factors to keep in mind when assessing whether PFG is the right investment in your portfolio.
Next Steps:
For consumer financials, there are three key aspects you should look at:
1. Financial health: Does it have a healthy balance sheet? Take a look at our free bank analysis with six simple checks on things like leverage and risk.
2. Future earnings: What does the market think of PFG going forward? Our analyst growth expectation chart helps visualize PFG’s growth potential over the upcoming years.
3. Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether PFG is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on PFG here.
To help readers see pass 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.
