An Intrinsic Value Calculation For River and Mercantile Group PLC (LON:RIV) Shows Investors Are Overpaying
Pricing RIV, a financial stock, can be difficult since these capital market businesses have cash flows that are affected by regulations that are not imposed upon other sectors. Asset managers, for example, must hold certain levels of capital in order to maintain a safe cash cushion. Examining factors such as book values, along with the return and cost of equity, may be suitable for gauging RIV’s intrinsic value. Today I’ll determine how to value RIV in a reasonably effective and easy way. See our latest analysis for River and Mercantile Group
Why Excess Return Model?
Two main things that set financial stocks apart from the rest are regulation and asset composition. United Kingdom’s financial regulatory environment is relatively strict. In addition, capital markets usually do not possess substantial portions of physical assets as part of total assets. 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.
Deriving RIV’s Intrinsic 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 above the cost of equity is known as excess returns:
Excess Return Per Share = (Stable Return On Equity – Cost Of Equity) (Book Value Of Equity Per Share)
= (20.22% – 8.89%) * £0.85 = £0.1
Excess Return Per Share is used to calculate the terminal value of RIV, 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)
= £0.1 / (8.89% – 1.49%) = £1.31
Putting this all together, we get the value of RIV’s share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= £0.85 + £1.31 = £2.16
Compared to the current share price of £3.09, RIV is priced above its true value. This means there’s no upside in buying RIV at its current price. Pricing is one part of the analysis of your potential investment in RIV. Fundamental factors are key to determining if RIV fits with the rest of your portfolio holdings.
Next Steps:
For capital markets, 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 leverage and risk.
2. Future earnings: What does the market think of RIV going forward? Our analyst growth expectation chart helps visualize RIV’s growth potential over the upcoming years.
3. Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether RIV is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on RIV 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.
