Power Corporation of Canada (TSE:POW) Investors Are Paying Above The Intrinsic Value
Valuing POW, an insurance stock, can be daunting since these financial firms generally have cash flows that are impacted by regulations that are not imposed upon other industries. For instance, insurance firms that invest excess premiums are required to maintain a certain level of reserves to reduce the risk to shareholders. Examining factors like book values, on top of the return and cost of equity, may be useful for calculating POW’s valuation. Below I will take you through how to value POW in a relatively accurate and uncomplicated way. View our latest analysis for Power of Canada
What Is The Excess Return Model?
Let’s keep in mind two things – regulation and type of assets. Financial firms operating in Canada face strict financial regulation. Moreover, insurance companies usually do not have large portions of physical assets on their balance sheet. While traditional DCF models emphasize on inputs such as capital expenditure and depreciation, which is less useful for a financial stock, the Excess Return model focuses on book values and stable earnings.
Deriving POW’s Intrinsic Value
The main 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 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)
= (8.44% – 12.35%) * CA$32.54 = CA$-1.27
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)
= CA$-1.27 / (12.35% – 2.13%) = CA$-12.43
These factors are combined to calculate the true value of POW’s stock:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= CA$32.54 + CA$-12.43 = CA$20.11
Relative to the present share price of CA$29.48, POW is currently overvalued. This means POW isn’t an attractive buy right now. Pricing is only one aspect when you’re looking at whether to buy or sell POW. Analyzing fundamental factors are equally important when it comes to determining if POW has a place in your holdings.
Next Steps:
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 POW going forward? Our analyst growth expectation chart helps visualize POW’s growth potential over the upcoming years.
Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether POW is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on POW 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.
