Walker & Dunlop Inc (NYSE:WD) Is Undervalued By 26%
Pricing bank stocks such as WD 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 example, businesses that deal with loans are required to hold more capital to reduce the risk to shareholders. Emphasizing data points such as book values, in addition to the return and cost of equity, can be appropriate for estimating WD’s value. Today I’ll look at how to value WD in a relatively useful and straightforward way. Check out our latest analysis for Walker & Dunlop
What Is The Excess Return Model?
Let’s keep in mind two things – regulation and type of assets. United States’s financial regulatory environment is relatively strict. Moreover, mortgage and thrift companies generally don’t hold substantial portions of tangible assets as part of total assets. 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.
How Does It Work?
The key assumption 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 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)
= (18.45% – 9.62%) * $35.2 = $3.11
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)
= $3.11 / (9.62% – 2.95%) = $46.66
Putting this all together, we get the value of WD’s share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $35.2 + $46.66 = $81.86
Relative to the present share price of $60.4, WD is , at this time, undervalued. Therefore, there is potential room to profit from mispricing if you bought WD at $81.86. Valuation is only one part of your investment analysis for whether to buy or sell WD. Fundamental factors are key to determining if WD fits with the rest of your portfolio holdings.
Next Steps:
For mortgage and thrift 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 bad loans and customer deposits.
Future earnings: What does the market think of WD going forward? Our analyst growth expectation chart helps visualize WD’s growth potential over the upcoming years.
Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether WD is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on WD 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.
