One of the most difficult industry to value is banking, given that they adhere to different rules compared to other companies. Banks, for example, must hold certain levels of tiered capital in order to maintain a safe cash cushion. Looking at line items like book values, on top of the return and cost of equity, may be useful for computing IBCP’s valuation. Today I’ll determine how to value IBCP in a relatively effective and simple way. See our latest analysis for Independent Bank
What Model Should You Use?
Financial firms differ to other sector firms primarily because of the kind of regulation they face and their asset composition. The regulatory environment in United States is fairly rigorous. Furthermore, banks usually do not have substantial amounts of physical 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.
How Does It Work?
The key belief for this model 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)
= (13.48% – 9.96%) x $15.03 = $0.53
Excess Return Per Share is used to calculate the terminal value of IBCP, 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)
= $0.53 / (9.96% – 2.95%) = $7.56
These factors are combined to calculate the true value of IBCP’s stock:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $15.03 + $7.56 = $22.59
This results in an intrinsic value of $22.59. Compared to the current share price of US$26.15, IBCP is currently trading in-line with its true value. Therefore, there’s a bit of a downside if you were to buy IBCP today. Pricing is only one aspect when you’re looking at whether to buy or sell IBCP. Analyzing fundamental factors are equally important when it comes to determining if IBCP 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 IBCP going forward? Our analyst growth expectation chart helps visualize IBCP’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether IBCP is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on IBCP 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.