If You Bought Shriram Transport Finance Company Limited (NSE:SRTRANSFIN) Today, There May Be An Upside

One of the most difficult industry to value is consumer finance, given that they adhere to different rules compared to other companies. For instance, these lenders must hold a certain level of cash reserves on the books as a safety precaution. Focusing on factors such as book values, on top of the return and cost of equity, can be useful for determining SRTRANSFIN’s true value. Below I’ll determine how to value SRTRANSFIN in a reasonably effective and simple method.

View our latest analysis for Shriram Transport Finance

Why 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 India is fairly rigorous. Moreover, consumer financials generally don’t possess substantial amounts of physical assets on their balance sheet. As traditional valuation models put weight on inputs such as capex and depreciation, which is less meaningful for finacial firms, the Excess Return model places importance on forecasting stable earnings and book values.

NSEI:SRTRANSFIN Intrinsic Value Export August 22nd 18
NSEI:SRTRANSFIN Intrinsic Value Export August 22nd 18

The Calculation

The main belief 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)

= (18.49% – 13.55%) x ₹768.45 = ₹37.97

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)

= ₹37.97 / (13.55% – 7.73%) = ₹652.8

Putting this all together, we get the value of SRTRANSFIN’s share:

Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share

= ₹768.45 + ₹652.8 = ₹1421.24

This results in an intrinsic value of ₹1421.36. Relative to the present share price of ₹1,331, SRTRANSFIN is priced in-line with its intrinsic value. This means SRTRANSFIN isn’t an attractive buy right now. Valuation is only one side of the coin when you’re looking to invest, or sell, SRTRANSFIN. Analyzing fundamental factors are equally important when it comes to determining if SRTRANSFIN has a place in your holdings.

Next Steps:

For consumer financials, 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 leverage and risk.
  2. Future earnings: What does the market think of SRTRANSFIN going forward? Our analyst growth expectation chart helps visualize SRTRANSFIN’s growth potential over the upcoming years.
  3. Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether SRTRANSFIN is a dividend Rockstar with our historical and future dividend analysis.

For more details and sources, take a look at our full calculation on SRTRANSFIN 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 editorial-team@simplywallst.com.