Pricing bank stocks such as PUB 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. Emphasizing line items such as book values, along with the return and cost of equity, is appropriate for assessing PUB’s value. Below I’ll take you through how to value PUB in a relatively useful and straightforward approach. Check out our latest analysis for People’s Utah Bancorp
Why Excess Return Model?
Financial firms differ to other sector firms primarily because of the kind of regulation they face and their asset composition. United States’s financial regulatory environment is relatively strict. Moreover, banks generally don’t hold large amounts of tangible assets as part of total assets. Therefore the Excess Returns model is appropriate for deriving the true value of PUB as opposed to the traditional model, which puts weight on factors such as capital expenditure and depreciation.
The key assumption for Excess Returns 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 in excess of cost of equity is called excess returns:
Excess Return Per Share = (Stable Return On Equity – Cost Of Equity) (Book Value Of Equity Per Share)
= (14.3% – 9.96%) x $16.18 = $0.70
Excess Return Per Share is used to calculate the terminal value of PUB, 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)
= $0.70 / (9.96% – 2.95%) = $10.04
Combining these components gives us PUB’s intrinsic value per share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $16.18 + $10.04 = $26.22
This results in an intrinsic value of $26.22. Given PUB’s current share price of US$37.30, PUB is currently trading above what it’s actually worth. This means PUB isn’t an attractive buy right now. Pricing is only one aspect when you’re looking at whether to buy or sell PUB. Fundamental factors are key to determining if PUB fits with the rest of your portfolio holdings.
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 PUB going forward? Our analyst growth expectation chart helps visualize PUB’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether PUB is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on PUB 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.