Pricing insurance stocks such as KMPR 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. Industry-specific factors, such as gross written premiums are crucial in understanding how insurance companies make money. Focusing on factors such as book values, along with the return and cost of equity, may be beneficial for estimating KMPR’s valuation. Today I will show you how to value KMPR in a fairly effective and straightforward way.
What Is The Excess Return Model?
There are two facets to consider: regulation and type of assets. Strict regulatory environment in United States’s finance industry reduces KMPR’s financial flexibility. Moreover, insurance companies tend to not hold significant amounts of physical assets on their balance sheet. 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 KMPR’s True Value
The central assumption 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)
= (11.49% – 8.6%) x $44.48 = $1.29
Excess Return Per Share is used to calculate the terminal value of KMPR, 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)
= $1.29 / (8.6% – 2.9%) = $22.8
Combining these components gives us KMPR’s intrinsic value per share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $44.48 + $22.8 = $67.27
This results in an intrinsic value of $67.27. Relative to the present share price of US$80.55, KMPR is fairly priced by the market. This means there’s no real upside in buying KMPR at its current price. Valuation is only one part of your investment analysis for whether to buy or sell KMPR. Fundamental factors are key to determining if KMPR fits with the rest of your portfolio holdings.
For insurance companies, 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 KMPR going forward? Our analyst growth expectation chart helps visualize KMPR’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether KMPR is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on KMPR 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 firstname.lastname@example.org.