Pricing GSY, a financial stock, can be difficult since consumer finance businesses have cash flows that are affected by regulations that are not imposed upon other sectors. For example, businesses that deal with loans are required to hold more capital to reduce the risk to shareholders. Looking at elements such as book values, with the return and cost of equity, may be appropriate for calculating GSY’s true value. Below I’ll take you through how to value GSY in a fairly effective and easy approach.
Why Excess Return Model?
Before we begin, remember that financial stocks differ in terms of regulation and balance sheet composition. The regulatory environment in Canada is fairly rigorous. Moreover, consumer financials generally don’t have significant portions of physical assets as part of total assets. 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.
Deriving GSY’s Intrinsic Value
The central assumption for this model 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)
= (0.22% – 14%) x CA$25.69 = CA$2.15
Excess Return Per Share is used to calculate the terminal value of GSY, 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$2.15 / (14% – 2.3%) = CA$18.91
Combining these components gives us GSY’s intrinsic value per share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= CA$25.69 + CA$18.91 = CA$44.6
This results in an intrinsic value of CA$44.6. Relative to today’s price of CA$39.20, GSY is currently trading in-line with its true value. Therefore, there’s a bit of a downside if you were to buy GSY today. Valuation is only one part of your investment analysis for whether to buy or sell GSY. Analyzing fundamental factors are equally important when it comes to determining if GSY has a place in your holdings.
For consumer financials, 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 leverage and risk.
- Future earnings: What does the market think of GSY going forward? Our analyst growth expectation chart helps visualize GSY’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether GSY is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on GSY 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 firstname.lastname@example.org.