Mortgage and thrift stocks such as FSBW are hard to value. This is because the rules financial firms face are different to other companies, which can impact the way we forecast their cash flows. For example, businesses that deal with loans are required to hold more capital to reduce the risk to shareholders. Focusing on elements such as book values, as well as the return and cost of equity, is fitting for assessing FSBW’s valuation. Below I’ll look at how to value FSBW in a relatively effective and easy way. Check out our latest analysis for FS Bancorp
Why Excess Return Model?
Two main things that set financial stocks apart from the rest are regulation and asset composition. Financial firms operating in United States face strict financial regulation. Moreover, mortgage and thrift companies tend to not possess substantial 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.
The main assumption 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 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)
= (13.1% – 9.08%) * $39.28 = $1.58
Excess Return Per Share is used to calculate the terminal value of FSBW, 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)
= $1.58 / (9.08% – 2.47%) = $23.88
These factors are combined to calculate the true value of FSBW’s stock:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $39.28 + $23.88 = $63.16
Relative to the present share price of $57.46, FSBW is , at this time, trading in-line with its true value. Therefore, there’s a bit of a downside if you were to buy FSBW today. Pricing is one part of the analysis of your potential investment in FSBW. There are other important factors to keep in mind when assessing whether FSBW is the right investment in your portfolio.
For mortgage and thrift companies, 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 bad loans and customer deposits.
2. Future earnings: What does the market think of FSBW going forward? Our analyst growth expectation chart helps visualize FSBW’s growth potential over the upcoming years.
3. Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether FSBW is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on FSBW 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.