Bank stocks such as GWB 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 instance, banks must hold a certain level of cash reserves on the books as a safety precaution. Emphasizing factors such as book values, on top of the return and cost of equity, may be fitting for assessing GWB’s valuation. Today I’ll take you through how to value GWB in a reasonably useful and simple approach.
What Is The Excess Return Model?
Two main things that set financial stocks apart from the rest are regulation and asset composition. GWB operates in United States which has stringent financial regulations. In addition, banks tend to not possess significant portions of physical assets on their books. Therefore the Excess Returns model is appropriate for deriving the true value of GWB as opposed to the traditional model, which puts weight on factors such as capital expenditure and depreciation.
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)
= (0.11% – 11%) x $34.12 = $0.030
Excess Return Per Share is used to calculate the terminal value of GWB, 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)
= $0.030 / (11% – 2.9%) = $0.36
Combining these components gives us GWB’s intrinsic value per share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $34.12 + $0.36 = $34.48
This results in an intrinsic value of $34.48. Given GWB’s current share price of US$39.55, GWB is fairly priced by the market. This means GWB isn’t an attractive buy right now. Pricing is one part of the analysis of your potential investment in GWB. Analyzing fundamental factors are equally important when it comes to determining if GWB 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 GWB going forward? Our analyst growth expectation chart helps visualize GWB’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether GWB is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on GWB 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.