Bank stocks such as TD are hard to value. This is because the rules banks face are different to other companies, which can impact the way we forecast their cash flows. Banks, for example, must hold certain levels of tiered capital in order to maintain a safe cash cushion. Emphasizing line items like book values, on top of the return and cost of equity, is suitable for calculating TD’s value. Below we’ll take a look at how to value TD in a reasonably accurate and straightforward method.
See our latest analysis for Toronto-Dominion Bank
What Is The Excess Return Model?
Let’s keep in mind two things – regulation and type of assets. Canada’s financial regulatory environment is relatively strict. Moreover, banks tend to not have large portions of tangible assets on their books. 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.
Deriving TD’s True Value
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 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)
= (0.16% – 10.0%) x CA$47.05 = CA$2.82
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)
= CA$2.82 / (10.0% – 2.3%) = CA$36.77
Putting this all together, we get the value of TD’s share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= CA$47.05 + CA$36.77 = CA$83.83
This results in an intrinsic value of CA$83.83. Relative to today’s price of CA$68.80, TD is currently priced in-line with its intrinsic value. Therefore, there’s a bit of a downside if you were to buy TD today. Pricing is only one aspect when you’re looking at whether to buy or sell TD. Fundamental factors are key to determining if TD fits with the rest of your portfolio holdings.
Next Steps:
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 TD going forward? Our analyst growth expectation chart helps visualize TD’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether TD is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on TD 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.