Pricing TOWN, 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 data points like book values, in addition to the return and cost of equity, may be fitting for assessing TOWN’s true value. Below we will look at how to value TOWN in a fairly effective and uncomplicated way. Check out our latest analysis for TowneBank
What Model Should You Use?
Let’s keep in mind two things – regulation and type of assets. United States’s financial regulatory environment is relatively strict. In addition to this, banks generally don’t have substantial amounts of physical assets on their books. 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.
Calculating TOWN’s Value
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 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)
= (10.37% – 9.87%) * $21.86 = $0.11
Excess Return Per Share is used to calculate the terminal value of TOWN, 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)
= $0.11 / (9.87% – 2.47%) = $1.48
Combining these components gives us TOWN’s intrinsic value per share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $21.86 + $1.48 = $23.34
Relative to the present share price of $29.25, TOWN is trading above what it’s actually worth. This means TOWN isn’t an attractive buy right now. Valuation is only one side of the coin when you’re looking to invest, or sell, TOWN. There are other important factors to keep in mind when assessing whether TOWN 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 TOWN going forward? Our analyst growth expectation chart helps visualize TOWN’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether TOWN is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on TOWN 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.