Capital market firms such as TRI are hard to value. This is because the rules they face are different to other companies, which can impact the way we forecast their cash flow. Maintaining a certain level of cash capital ratio is common for these financial firms to abide by, in order to minimize risks to their shareholders. Emphasizing data points such as book values, as well as the return and cost of equity, is practical for gauging TRI’s intrinsic value. Below we’ll take a look at how to value TRI in a reasonably accurate and simple way. Check out our latest analysis for Thomson Reuters
What Is The Excess Return Model?
Two main things that set financial stocks apart from the rest are regulation and asset composition. Canada’s financial regulatory environment is relatively strict. In addition to this, capital markets generally don’t hold significant 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.
Deriving TRI’s True Value
The key belief 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)
= (14.01% – 8.43%) * $17.91 = $1.03
Excess Return Per Share is used to calculate the terminal value of TRI, 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)
= $1.03 / (8.43% – 2.13%) = $16.29
These factors are combined to calculate the true value of TRI’s stock:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $17.91 + $16.29 = CA$44.46
Relative to today’s price of $56.9, TRI is currently overvalued. This means there’s no upside in buying TRI at its current price. Valuation is only one part of your investment analysis for whether to buy or sell TRI. Analyzing fundamental factors are equally important when it comes to determining if TRI has a place in your holdings.
For capital markets, 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 TRI going forward? Our analyst growth expectation chart helps visualize TRI’s growth potential over the upcoming years.
3. Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether TRI is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on TRI here.