Bank stocks such as BUSE are hard to value. This is because the rules banks face are different to other companies, which can impact the way we forecast their cash flows. For example, banks are required to hold more capital to reduce the risk to depositors. Focusing on data points like book values, with the return and cost of equity, may be practical for calculating BUSE’s value. Below I’ll look at how to value BUSE in a fairly effective and simple way.
What Is The Excess Return Model?
Before we begin, remember that financial stocks differ in terms of regulation and balance sheet composition. Strict regulatory environment in United States’s finance industry reduces BUSE’s financial flexibility. Furthermore, banks generally don’t have substantial amounts of physical assets on their balance sheet. So the Excess Returns model is suitable for determining the intrinsic value of BUSE rather than the traditional discounted cash flow model, which places emphasis on factors such as depreciation and capex.
The central assumption 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 above the cost of equity is known as excess returns:
Excess Return Per Share = (Stable Return On Equity – Cost Of Equity) (Book Value Of Equity Per Share)
= (10.93% – 9.82%) x $21.37 = $0.24
Excess Return Per Share is used to calculate the terminal value of BUSE, 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)
= $0.24 / (9.82% – 2.95%) = $3.47
These factors are combined to calculate the true value of BUSE’s stock:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $21.37 + $3.47 = $24.84
This results in an intrinsic value of $24.84. Relative to today’s price of US$31.09, BUSE is priced above its true value. This means BUSE isn’t an attractive buy right now. Pricing is one part of the analysis of your potential investment in BUSE. Analyzing fundamental factors are equally important when it comes to determining if BUSE has a place in your 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 BUSE going forward? Our analyst growth expectation chart helps visualize BUSE’s growth potential over the upcoming years.
Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether BUSE is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on BUSE 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 email@example.com.