BAC operates in the banking industry, which has characteristics that make it unique compared to other sectors. Understanding these differences is crucial when it comes to putting a value on the bank stock. The tiered capital structure is common for banks to abide by, in order to ensure they maintain a sufficient level of cash for their customers. Looking at data points like book values, as well as the return and cost of equity, can be fitting for calculating BAC’s valuation. Below we’ll take a look at how to value BAC in a reasonably accurate and straightforward way. View out our latest analysis for Bank of America
What Is The Excess Return Model?
There are two facets to consider: regulation and type of assets. Financial firms operating in United States face strict financial regulation. In addition, banks tend to not hold large portions of physical assets as part of total assets. So the Excess Returns model is suitable for determining the intrinsic value of BAC rather than the traditional discounted cash flow model, which places emphasis on factors such as depreciation and capex.
Calculating BAC’s Value
The key 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)
= (10.92% – 9.95%) x $25.93 = $0.25
Excess Return Per Share is used to calculate the terminal value of BAC, 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)
= $0.25 / (9.95% – 2.95%) = $3.58
These factors are combined to calculate the true value of BAC’s stock:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $25.93 + $3.58 = $29.51
This results in an intrinsic value of $29.51. Given BAC’s current share price of US$28.99, BAC is currently fairly priced by the market. This means BAC isn’t an attractive buy right now. Valuation is only one side of the coin when you’re looking to invest, or sell, BAC. Fundamental factors are key to determining if BAC fits with the rest of your portfolio 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 BAC going forward? Our analyst growth expectation chart helps visualize BAC’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether BAC is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on BAC here.