Pricing SFST, a financial stock, can be difficult since these banks have cash flows that are affected by regulations that are not imposed upon other sectors. Banks, for example, must hold certain levels of tiered capital in order to maintain a safe cash cushion. Focusing on factors such as book values, on top of the return and cost of equity, may be fitting for computing SFST’s value. Today I will take you through how to value SFST in a relatively useful and simple method.
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Why Excess Return Model?
Two main things that set financial stocks apart from the rest are regulation and asset composition. SFST operates in United States which has stringent financial regulations. In addition to this, banks tend to not have substantial portions of physical assets on their balance sheet. The Excess Returns model overcomes the required capital kept on hand and lack of tangibles by focusing on forecasting stable earnings, rather than less relevant factors such as depreciation and capex, which more traditional models focus on.
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 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)
= (0.11% – 11%) x $27.34 = $0.19
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)
= $0.19 / (11% – 2.7%) = $2.41
These factors are combined to calculate the true value of SFST’s stock:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $27.34 + $2.41 = $29.75
This results in an intrinsic value of $29.75. Given SFST’s current share price of US$32.30, SFST is , at this time, priced in-line with its intrinsic value. This means there’s no real upside in buying SFST at its current price. Pricing is only one aspect when you’re looking at whether to buy or sell SFST. There are other important factors to keep in mind when assessing whether SFST is the right investment in your portfolio.
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 SFST going forward? Our analyst growth expectation chart helps visualize SFST’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether SFST is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on SFST 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.