Consumer finance firms such as CAPF 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. For example, businesses that deal with loans are required to hold more capital to reduce the risk to shareholders. Focusing on elements such as book values, in addition to the return and cost of equity, may be appropriate for determining CAPF’s valuation. Today I will show you how to value CAPF in a reasonably effective and easy approach.
What Is The Excess Return Model?
Two main things that set financial stocks apart from the rest are regulation and asset composition. Financial firms operating in India face strict financial regulation. Furthermore, consumer financials usually do not have large amounts of tangible assets on their books. Therefore the Excess Returns model is appropriate for deriving the true value of CAPF as opposed to the traditional model, which puts weight on factors such as capital expenditure and depreciation.
Calculating CAPF’s Value
The central 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 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)
= (16.68% – 13.55%) x ₹349.92 = ₹10.97
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)
= ₹10.97 / (13.55% – 7.73%) = ₹188.67
These factors are combined to calculate the true value of CAPF’s stock:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= ₹349.92 + ₹188.67 = ₹538.59
This results in an intrinsic value of ₹539.96. Relative to today’s price of ₹532, CAPF is currently priced in-line with its intrinsic value. This means CAPF isn’t an attractive buy right now. Valuation is only one side of the coin when you’re looking to invest, or sell, CAPF. Fundamental factors are key to determining if CAPF fits with the rest of your portfolio 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 CAPF going forward? Our analyst growth expectation chart helps visualize CAPF’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether CAPF is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on CAPF 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 email@example.com.