Investors Are Undervaluing National Australia Bank Limited (ASX:NAB) By 25.88%
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Pricing bank stocks such as NAB 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. Examining factors like book values, along with the return and cost of equity, can be suitable for evaluating NAB’s true value. Below I will take you through how to value NAB in a relatively accurate and simple approach.
View our latest analysis for National Australia Bank
Why Excess Return Model?
Financial firms differ to other sector firms primarily because of the kind of regulation they face and their asset composition. Financial firms operating in Australia face strict financial regulation. Moreover, banks usually do not hold large amounts of physical assets as part of total assets. As traditional valuation models put weight on inputs such as capex and depreciation, which is less meaningful for finacial firms, the Excess Return model places importance on forecasting stable earnings and book values.
Deriving NAB’s True Value
The key belief for Excess Returns 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)
= (0.13% – 8.5%) x A$19.82 = A$0.83
Excess Return Per Share is used to calculate the terminal value of NAB, 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)
= A$0.83 / (8.5% – 2.3%) = A$13.57
Combining these components gives us NAB’s intrinsic value per share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= A$19.82 + A$13.57 = A$33.39
This results in an intrinsic value of A$33.39. Compared to the current share price of AU$24.75, NAB is currently priced beneath its true value. This means you can buy NAB at a discount to its value of A$33.39. Pricing is one part of the analysis of your potential investment in NAB. Fundamental factors are key to determining if NAB fits with the rest of your portfolio holdings.
Next Steps:
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 NAB going forward? Our analyst growth expectation chart helps visualize NAB’s growth potential over the upcoming years.
Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether NAB is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on NAB 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 editorial-team@simplywallst.com.
