One of the most difficult industry to value is banking, given that they adhere to different rules compared to other companies. 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 elements such as book values, along with the return and cost of equity, is practical for calculating C’s valuation. Today I will take you through how to value C in a fairly useful and simple method. View our latest analysis for Citigroup
What Is The Excess Return Model?
Financial firms differ to other sector firms primarily because of the kind of regulation they face and their asset composition. Strict regulatory environment in United States’s finance industry reduces C’s financial flexibility. In addition to this, banks usually do not hold large amounts of tangible assets as part of total assets. This means the Excess Returns model is best suited for calculating the intrinsic value of C rather than the traditional discounted cash flow model, which has more emphasis on things like capital expenditure and depreciation.
Calculating C’s Value
The key 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 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)
= (9.25% – 9.92%) * $78.92 = $-0.52
Excess Return Per Share is used to calculate the terminal value of C, 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)
= $-0.52 / (9.92% – 2.47%) = $-7.04
Combining these components gives us C’s intrinsic value per share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $78.92 + $-7.04 = $71.88
Relative to today’s price of $67.94, C is currently fairly priced by the market. This means C isn’t an attractive buy right now. Valuation is only one part of your investment analysis for whether to buy or sell C. There are other important factors to keep in mind when assessing whether C is the right investment in your portfolio.
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 C going forward? Our analyst growth expectation chart helps visualize C’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether C is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on C here.