NZX Limited (NZE:NZX) Investors Are Paying Above The Intrinsic Value

Simply Wall St
April 20, 2018
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NZX operates in the capital markets sector, which has characteristics that make it unique to other industries. Understanding these differences is crucial when it comes to putting a value on the financial stock. For example, capital market businesses are required to hold more capital to reduce the risk to shareholders. Emphasizing factors such as book values, along with the return and cost of equity, can be appropriate for estimating NZX’s true value. Below we’ll take a look at how to value NZX in a fairly useful and easy approach. See our latest analysis for NZX

Why Excess Return Model?

Let's keep in mind two things – regulation and type of assets. Strict regulatory environment in New Zealand's finance industry reduces NZX's financial flexibility. In addition to this, capital markets tend to not have significant amounts of tangible assets on their books. The Excess Returns model overcomes the required capital kept on hand and lack of tangibles by focusing on forecasting stable earnings, rather than less relevant factors such as depreciation and capex, which more traditional models focus on.

NZSE:NZX Intrinsic Value Apr 20th 18
NZSE:NZX Intrinsic Value Apr 20th 18

The Calculation

The central assumption 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 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)

= (21.44% – 8.55%) * NZ$0.25 = NZ$0.03

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

= NZ$0.03 / (8.55% – 2.76%) = NZ$0.56

Putting this all together, we get the value of NZX’s share:

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

= NZ$0.25 + NZ$0.56 = NZ$0.82

Given NZX's current share price of NZ$1.07, NZX is overvalued. This means there's no upside in buying NZX at its current price. Valuation is only one side of the coin when you’re looking to invest, or sell, NZX. Analyzing fundamental factors are equally important when it comes to determining if NZX has a place in your holdings.

Next Steps:

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

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