Pricing bank stocks such as IBCP is particularly challenging. Given that these companies adhere to a different set of rules relative to other companies, their cash flows should also be valued differently. 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, in addition to the return and cost of equity, can be practical for gauging IBCP’s valuation. Below I will show you how to value IBCP in a fairly accurate and easy method.
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What Is The Excess Return Model?
Before we begin, remember that financial stocks differ in terms of regulation and balance sheet composition. Financial firms operating in United States face strict financial regulation. In addition to this, banks usually do not possess large portions of tangible assets on their balance sheet. Therefore the Excess Returns model is appropriate for deriving the true value of IBCP as opposed to the traditional model, which puts weight on factors such as capital expenditure and depreciation.
The main belief 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 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% – 11%) x $16.3 = $0.35
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)
= $0.35 / (11% – 2.7%) = $4.09
Putting this all together, we get the value of IBCP’s share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $16.3 + $4.09 = $20.39
This results in an intrinsic value of $20.39. Given IBCP’s current share price of US$22.02, IBCP is priced in-line with its intrinsic value. This means there’s no real upside in buying IBCP at its current price. Pricing is one part of the analysis of your potential investment in 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 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.