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Pricing CADE, a financial stock, can be difficult since these banks have cash flows that are affected by regulations that are not imposed upon other sectors. For instance, banks must hold a certain level of cash reserves on the books as a safety precaution. Focusing on elements like book values, on top of the return and cost of equity, can be suitable for estimating CADE’s true value. Below I’ll take you through how to value CADE in a relatively accurate and simple way.

### Why Excess Return Model?

Before we begin, remember that financial stocks differ in terms of regulation and balance sheet composition. CADE operates in United States which has stringent financial regulations. In addition to this, banks usually do not hold significant amounts of tangible assets as part of total assets. 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.

The key assumption for Excess Returns is that equity value is how much the firm can earn, over and above its cost of equity, given the level of equity it has in the company at the moment. 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)

= (11.11% – 9.80%) x \$21.48 = \$0.28

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)

= \$0.28 / (9.80% – 2.95%) = \$4.09

These factors are combined to calculate the true value of CADE’s stock:

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

= \$21.48 + \$4.09 = \$25.57

This results in an intrinsic value of \$25.57. Relative to the present share price of US\$29.56, CADE is trading in-line with its true value. This means there’s no real upside in buying CADE at its current price. Valuation is only one part of your investment analysis for whether to buy or sell CADE. Analyzing fundamental factors are equally important when it comes to determining if CADE has a place in your holdings.

### Next Steps:

For banks, 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 bad loans and customer deposits.
2. Future earnings: What does the market think of CADE going forward? Our analyst growth expectation chart helps visualize CADE’s growth potential over the upcoming years.
3. Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether CADE is a dividend Rockstar with our historical and future dividend analysis.

For more details and sources, take a look at our full calculation on CADE here.

To help readers see pass 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 editorial-team@simplywallst.com.