Pricing CSFL, a financial stock, can be difficult since these banks have cash flows that are affected by regulations that are not imposed upon other sectors. For example, banks are required to hold more capital to reduce the risk to depositors. Looking at data points like book values, in addition to the return and cost of equity, may be appropriate for estimating CSFL’s true value. Today we’ll take a look at how to value CSFL in a reasonably useful and uncomplicated method.
What Is The Excess Return Model?
There are two facets to consider: regulation and type of assets. United States’s financial regulatory environment is relatively strict. Furthermore, banks usually do not hold significant portions of physical assets as part of total assets. As traditional valuation models put weight on inputs such as capex and depreciation, which is less meaningful for finacial firms, the Excess Return model places importance on forecasting stable earnings and book values.
How Does It Work?
The key belief for this model is, the value of the company is how much money it can generate from its current level of equity capital, in excess of the cost of that capital. 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)
= (0.12% – 11%) x $20.97 = $0.15
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)
= $0.15 / (11% – 2.9%) = $1.84
Putting this all together, we get the value of CSFL’s share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $20.97 + $1.84 = $22.8
This results in an intrinsic value of $22.8. Given CSFL’s current share price of US$23.94, CSFL is currently trading in-line with its true value. Therefore, there’s a bit of a downside if you were to buy CSFL today. Valuation is only one part of your investment analysis for whether to buy or sell CSFL. Fundamental factors are key to determining if CSFL fits with the rest of your portfolio holdings.
For banks, there are three key aspects you should look at:
- Financial health: Does it have a healthy balance sheet? Take a look at our free bank analysis with six simple checks on things like bad loans and customer deposits.
- Future earnings: What does the market think of CSFL going forward? Our analyst growth expectation chart helps visualize CSFL’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether CSFL is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on CSFL 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 firstname.lastname@example.org.