BOC Hong Kong (Holdings) Limited (HKG:2388) Is Trading At A 4.64% Discount

Bank stocks such as 2388 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. For example, banks are required to hold more capital to reduce the risk to depositors. Emphasizing data points such as book values, on top of the return and cost of equity, may be useful for evaluating 2388’s valuation. Below I’ll determine how to value 2388 in a relatively accurate and uncomplicated method.

View our latest analysis for BOC Hong Kong (Holdings)

Why Excess Return Model?

Let’s keep in mind two things – regulation and type of assets. Financial firms operating in Hong Kong face strict financial regulation. Furthermore, banks usually do not have substantial portions of physical assets on their balance sheet. This means the Excess Returns model is best suited for calculating the intrinsic value of 2388 rather than the traditional discounted cash flow model, which has more emphasis on things like capital expenditure and depreciation.

SEHK:2388 Intrinsic Value Export October 24th 18
SEHK:2388 Intrinsic Value Export October 24th 18

The Calculation

The key 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 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)

= (0.14% – 11%) x HK$26.68 = HK$0.72

Excess Return Per Share is used to calculate the terminal value of 2388, 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)

= HK$0.72 / (11% – 2.2%) = HK$8.19

These factors are combined to calculate the true value of 2388’s stock:

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

= HK$26.68 + HK$8.19 = HK$34.87

This results in an intrinsic value of HK$34.87. Relative to the present share price of HK$33.25, 2388 is , at this time, trading in-line with its true value. This means there’s no real upside in buying 2388 at its current price. Valuation is only one part of your investment analysis for whether to buy or sell 2388. Analyzing fundamental factors are equally important when it comes to determining if 2388 has a place in your holdings.

Next Steps:

For banks, 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 bad loans and customer deposits.
  2. Future earnings: What does the market think of 2388 going forward? Our analyst growth expectation chart helps visualize 2388’s growth potential over the upcoming years.
  3. Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether 2388 is a dividend Rockstar with our historical and future dividend analysis.

For more details and sources, take a look at our full calculation on 2388 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.