Investors Are Undervaluing 3i Group plc (LON:III) By 39%
III operates in the capital markets sector, which has characteristics that make it unique to other industries. Understanding these differences is crucial when it comes to putting a value on the financial stock. For instance, these businesses must hold a certain level of cash reserves on the books as a safety precaution. Examining elements like book values, on top of the return and cost of equity, may be appropriate for computing III’s value. Today I’ll look at how to value III in a fairly effective and uncomplicated method. View our latest analysis for 3i Group
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. Strict regulatory environment in United Kingdom’s finance industry reduces III’s financial flexibility. In addition to this, capital markets tend to not hold large portions of physical 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 III’s Value
The main belief for this model is, the value of the company is how much money it can generate from its current level of equity capital, in excess of the cost of that capital. 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)
= (15.11% – 9.44%) * £8.59 = £0.49
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)
= £0.49 / (9.44% – 1.49%) = £6.12
Putting this all together, we get the value of III’s share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= £8.59 + £6.12 = £14.72
Relative to the present share price of £8.97, III is currently priced beneath its true value. Therefore, there is potential room to profit from mispricing if you bought III at £14.72. Pricing is only one aspect when you’re looking at whether to buy or sell III. Analyzing fundamental factors are equally important when it comes to determining if III has a place in your holdings.
Next Steps:
For capital markets, 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 III going forward? Our analyst growth expectation chart helps visualize III’s growth potential over the upcoming years.
Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether III is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on III 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.
