Pricing capital market stocks such as BAER is particularly challenging. Given that these companies adhere to a different set of rules relative to other companies, their cash flows should also be valued differently. For example, capital market businesses are required to hold more capital to reduce the risk to shareholders. Examining factors such as book values, as well as the return and cost of equity, can be appropriate for evaluating BAER’s valuation. Today I will take you through how to value BAER in a reasonably useful and straightforward way.
Why Excess Return Model?
Financial firms differ to other sector firms primarily because of the kind of regulation they face and their asset composition. Financial firms operating in Switzerland face strict financial regulation. In addition to this, capital markets usually do not have substantial amounts 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 BAER’s True Value
The central 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 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)
= (0.16% – 10%) x CHF30.77 = CHF1.6
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)
= CHF1.6 / (10% – 3.7%) = CHF23.94
Putting this all together, we get the value of BAER’s share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= CHF30.77 + CHF23.94 = CHF54.71
This results in an intrinsic value of CHF54.71. Relative to today’s price of CHF45.88, BAER is , at this time, fairly priced by the market. Therefore, there’s a bit of a downside if you were to buy BAER today. Pricing is one part of the analysis of your potential investment in BAER. Analyzing fundamental factors are equally important when it comes to determining if BAER has a place in your holdings.
For capital markets, 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 BAER going forward? Our analyst growth expectation chart helps visualize BAER’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether BAER is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on BAER 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.