People’s United Financial Inc (NASDAQ:PBCT) Investors Are Paying Above The Intrinsic Value
Bank stocks such as PBCT are hard to value. This is because the rules banks face are different to other companies, which can impact the way we forecast their cash flows. For instance, banks must hold a certain level of cash reserves on the books as a safety precaution. Examining line items like book values, with the return and cost of equity, is appropriate for evaluating PBCT’s intrinsic value. Today I’ll take you through how to value PBCT in a relatively useful and uncomplicated approach. See our latest analysis for People’s United Financial
What Is The Excess Return Model?
Before we begin, remember that financial stocks differ in terms of regulation and balance sheet composition. Strict regulatory environment in United States’s finance industry reduces PBCT’s financial flexibility. Moreover, banks tend to not possess large portions 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.
How Does It Work?
The key 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)
= (8.63% – 9.90%) * $17.6 = $-0.22
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)
= $-0.22 / (9.90% – 2.47%) = $-3.01
Putting this all together, we get the value of PBCT’s share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $17.6 + $-3.01 = $14.59
Relative to the present share price of $18.57, PBCT is , at this time, overvalued. This means PBCT isn’t an attractive buy right now. Valuation is only one part of your investment analysis for whether to buy or sell PBCT. Fundamental factors are key to determining if PBCT 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 PBCT going forward? Our analyst growth expectation chart helps visualize PBCT’s growth potential over the upcoming years.
Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether PBCT is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on PBCT 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.
