Mortgage and thrift stocks such as EQB are hard to value. This is because the rules financial firms face are different to other companies, which can impact the way we forecast their cash flows. For instance, these lenders must hold a certain level of cash reserves on the books as a safety precaution. Emphasizing line items such as book values, along with the return and cost of equity, can be appropriate for computing EQB’s intrinsic value. Today we’ll take a look at how to value EQB in a fairly useful and easy method.
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. Canada's financial regulatory environment is relatively strict. Furthermore, mortgage and thrift companies tend to not possess large portions of physical assets on their books. Therefore the Excess Returns model is appropriate for deriving the true value of EQB as opposed to the traditional model, which puts weight on factors such as capital expenditure and depreciation.
How Does It Work?
The main 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 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)
= (0.14% – 11.8%) x CA$80.26 = CA$1.62
Excess Return Per Share is used to calculate the terminal value of EQB, 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)
= CA$1.62 / (11.8% – 2.3%) = CA$17.07
These factors are combined to calculate the true value of EQB's stock:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= CA$80.26 + CA$17.07 = CA$97.33
This results in an intrinsic value of CA$97.33. Given EQB's current share price of CA$68.51, EQB is currently priced beneath its true value. This means there's an upside to buying EQB today. Pricing is only one aspect when you're looking at whether to buy or sell EQB. Fundamental factors are key to determining if EQB fits with the rest of your portfolio holdings.
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 EQB going forward? Our analyst growth expectation chart helps visualize EQB’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether EQB is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on EQB 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 email@example.com.
Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.