Pricing bank stocks such as SASR 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. For instance, banks must hold a certain level of cash reserves on the books as a safety precaution. Emphasizing line items such as book values, on top of the return and cost of equity, is fitting for evaluating SASR’s intrinsic value. Below we’ll take a look at how to value SASR in a fairly effective and straightforward approach. View our latest analysis for Sandy Spring Bancorp
What Is The Excess Return Model?
Financial firms differ to other sector firms primarily because of the kind of regulation they face and their asset composition. The regulatory environment in United States is fairly rigorous. In addition, banks tend to not possess large portions of physical assets as part of total assets. Therefore the Excess Returns model is appropriate for deriving the true value of SASR as opposed to the traditional model, which puts weight on factors such as capital expenditure and depreciation.
The main assumption 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 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)
= (10.58% – 8.49%) * $23.53 = $0.49
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)
= $0.49 / (8.49% – 2.47%) = $8.15
These factors are combined to calculate the true value of SASR’s stock:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $23.53 + $8.15 = $31.68
Relative to today’s price of $40.86, SASR is , at this time, trading above what it’s actually worth. Therefore, there’s no benefit to buying SASR today. Pricing is one part of the analysis of your potential investment in SASR. Analyzing fundamental factors are equally important when it comes to determining if SASR has a place in your holdings.
For banks, there are three key aspects you should look at:
1. 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.
2. Future earnings: What does the market think of SASR going forward? Our analyst growth expectation chart helps visualize SASR’s growth potential over the upcoming years.
3. Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether SASR is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on SASR 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.