Industrial Alliance Insurance and Financial Services Inc (TSE:IAG) Is Trading 25% Below Its True Value

By
Simply Wall St
Published
May 07, 2018
TSX:IAG
Source: Shutterstock

Pricing IAG, a financial stock, can be difficult since these insurance businesses have cash flows that are affected by regulations that are not imposed upon other sectors. For example, insurance firms don’t have gross profits as such, but gross written premiums play a huge part in forecasting cash flows. Examining data points like book values, in addition to the return and cost of equity, can be practical for evaluating IAG’s true value. Below I’ll take you through how to value IAG in a relatively accurate and straightforward approach. View our latest analysis for Industrial Alliance Insurance and Financial Services

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 Canada is fairly rigorous. Furthermore, insurance companies tend to not hold substantial amounts of tangible assets as part of total assets. Therefore the Excess Returns model is appropriate for deriving the true value of IAG as opposed to the traditional model, which puts weight on factors such as capital expenditure and depreciation.

TSX:IAG Intrinsic Value May 7th 18
TSX:IAG Intrinsic Value May 7th 18

The Calculation

The main belief for this model 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)

= (11.68% – 9.13%) * CA$50.62 = CA$1.29

Excess Return Per Share is used to calculate the terminal value of IAG, 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$1.29 / (9.13% – 2.13%) = CA$18.42

These factors are combined to calculate the true value of IAG's stock:

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

= CA$50.62 + CA$18.42 = CA$69.04

Compared to the current share price of CA$52, IAG is priced below its intrinsic value. This means there's an upside to buying IAG today. Valuation is only one part of your investment analysis for whether to buy or sell IAG. There are other important factors to keep in mind when assessing whether IAG is the right investment in your portfolio.

Next Steps:

For insurance companies, 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 IAG going forward? Our analyst growth expectation chart helps visualize IAG’s growth potential over the upcoming years.
  3. Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether IAG is a dividend Rockstar with our historical and future dividend analysis.

For more details and sources, take a look at our full calculation on IAG here.

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.

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