Insurance stocks such as IFC 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, insurance companies are required to hold more capital to reduce the risk to shareholders. Looking at factors like book values, in addition to the return and cost of equity, may be suitable for determining IFC’s value. Below we will look at how to value IFC in a reasonably useful and simple method.
What Is The Excess Return Model?
Let’s keep in mind two things – regulation and type of assets. Financial firms operating in Canada face strict financial regulation. In addition, insurance companies usually do not hold significant amounts of tangible assets on their books. The Excess Returns model overcomes the required capital kept on hand and lack of tangibles by focusing on forecasting stable earnings, rather than less relevant factors such as depreciation and capex, which more traditional models focus on.
Calculating IFC’s Value
The central 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)
= (0.13% – 8.5%) x CA$54.75 = CA$2.56
We use this value to calculate the terminal value of the company, which is how much we expect the company to continue to earn every year, forever. This is a common component of discounted cash flow models:
Terminal Value Per Share = Excess Return Per Share / (Cost of Equity – Expected Growth Rate)
= CA$2.56 / (8.5% – 2.3%) = CA$41.81
Combining these components gives us IFC’s intrinsic value per share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= CA$54.75 + CA$41.81 = CA$96.56
This results in an intrinsic value of CA$96.56. Given IFC’s current share price of CA$101, IFC is , at this time, priced in-line with its intrinsic value. Therefore, there’s a bit of a downside if you were to buy IFC today. Pricing is one part of the analysis of your potential investment in IFC. Fundamental factors are key to determining if IFC fits with the rest of your portfolio holdings.
For insurance companies, 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 leverage and risk.
- Future earnings: What does the market think of IFC going forward? Our analyst growth expectation chart helps visualize IFC’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether IFC is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on IFC 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.