Pricing bank stocks such as COLB 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. The tiered capital structure is common for banks to abide by, in order to ensure they maintain a sufficient level of cash for their customers. Looking at elements such as book values, on top of the return and cost of equity, may be fitting for evaluating COLB’s valuation. Today I will take you through how to value COLB in a reasonably useful and straightforward approach. See our latest analysis for Columbia Banking System
What Is The Excess Return Model?
Before we begin, remember that financial stocks differ in terms of regulation and balance sheet composition. COLB operates in United States which has stringent financial regulations. Moreover, banks tend to not possess significant portions of tangible assets on their balance sheet. This means the Excess Returns model is best suited for calculating the intrinsic value of COLB rather than the traditional discounted cash flow model, which has more emphasis on things like capital expenditure and depreciation.
Calculating COLB’s Value
The key assumption 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)
= (9.81% – 9.77%) * $29.97 = $0.01
Excess Return Per Share is used to calculate the terminal value of COLB, 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)
= $0.01 / (9.77% – 2.47%) = $0.17
These factors are combined to calculate the true value of COLB’s stock:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $29.97 + $0.17 = $30.14
Relative to today’s price of $45.58, COLB is currently overvalued. This means COLB isn’t an attractive buy right now. Valuation is only one side of the coin when you’re looking to invest, or sell, COLB. There are other important factors to keep in mind when assessing whether COLB is the right investment in your portfolio.
For banks, 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 COLB going forward? Our analyst growth expectation chart helps visualize COLB’s growth potential over the upcoming years.
3. Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether COLB is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on COLB 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.