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Cholamandalam Investment and Finance Company Limited (NSE:CHOLAFIN) Investors Are Paying Above The Intrinsic Value

Pricing consumer finance stocks such as CHOLAFIN is particularly challenging. Given that these companies adhere to a different set of rules relative to other companies, their cash flows should also be valued differently. These lenders, for example, must hold certain levels of capital in order to maintain a safe cash cushion. Emphasizing factors like book values, in addition to the return and cost of equity, may be fitting for evaluating CHOLAFIN’s intrinsic value. Today I will take you through how to value CHOLAFIN in a fairly useful and easy way.

Check out our latest analysis for Cholamandalam Investment and Finance

What Model Should You Use?

There are two facets to consider: regulation and type of assets. Strict regulatory environment in India’s finance industry reduces CHOLAFIN’s financial flexibility. In addition to this, consumer financials tend to not hold substantial amounts of tangible assets on their balance sheet. 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.

NSEI:CHOLAFIN Intrinsic Value Export December 7th 18

Deriving CHOLAFIN’s Intrinsic Value

The key belief for Excess Returns 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)

= (0.21% – 14%) x ₹479.99 = ₹36.85

Excess Return Per Share is used to calculate the terminal value of CHOLAFIN, which is how much the business is expected to continue to generate over the upcoming years, in perpetuity. This is a common component of discounted cash flow models:

Terminal Value Per Share = Excess Return Per Share / (Cost of Equity – Expected Growth Rate)

= ₹36.85 / (14% – 7.7%) = ₹633.58

Putting this all together, we get the value of CHOLAFIN’s share:

Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share

= ₹479.99 + ₹633.58 = ₹1113.57

This results in an intrinsic value of ₹1161.42. Relative to today’s price of ₹1,278, CHOLAFIN is , at this time, priced in-line with its intrinsic value. This means CHOLAFIN isn’t an attractive buy right now. Valuation is only one part of your investment analysis for whether to buy or sell CHOLAFIN. There are other important factors to keep in mind when assessing whether CHOLAFIN 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 CHOLAFIN going forward? Our analyst growth expectation chart helps visualize CHOLAFIN’s growth potential over the upcoming years.
  3. Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether CHOLAFIN is a dividend Rockstar with our historical and future dividend analysis.

For more details and sources, take a look at our full calculation on CHOLAFIN 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.