Pricing bank stocks such as SPOG 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, banks are required to hold more capital to reduce the risk to depositors. Looking at line items like book values, along with the return and cost of equity, is beneficial for assessing SPOG’s valuation. Today I will show you how to value SPOG in a fairly useful and simple approach.
What Is The Excess Return Model?
There are two facets to consider: regulation and type of assets. The regulatory environment in Norway is fairly rigorous. Moreover, banks usually do not have substantial amounts of tangible assets on their balance sheet. Excess Returns overcome some of these issues. Firstly, it doesn’t focus on factors such as capex and depreciation – relevant for tangible asset firms – but rather emphasize forecasting stable earnings and book values.
How Does It Work?
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)
= (0.084% – 8.4%) x NOK62.91 = NOK0.056
Excess Return Per Share is used to calculate the terminal value of SPOG, 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)
= NOK0.056 / (8.4% – 1.8%) = NOK0.85
Putting this all together, we get the value of SPOG’s share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= NOK62.91 + NOK0.85 = NOK63.77
This results in an intrinsic value of NOK63.77. Given SPOG’s current share price of øre57.00, SPOG is priced in-line with its intrinsic value. This means SPOG isn’t an attractive buy right now. Pricing is one part of the analysis of your potential investment in SPOG. Analyzing fundamental factors are equally important when it comes to determining if SPOG has a place in your holdings.
For banks, 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 bad loans and customer deposits.
- Future earnings: What does the market think of SPOG going forward? Our analyst growth expectation chart helps visualize SPOG’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether SPOG is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on SPOG 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.