One of the most difficult industry to value is banking, given that they adhere to different rules compared to other companies. For instance, banks must hold a certain level of cash reserves on the books as a safety precaution. Looking at data points such as book values, along with the return and cost of equity, may be suitable for gauging STL’s valuation. Today I will show you how to value STL in a fairly accurate and uncomplicated way.
Why Excess Return Model?
Financial firms differ to other sector firms primarily because of the kind of regulation they face and their asset composition. STL operates in United States which has stringent financial regulations. In addition to this, banks usually do not have substantial portions of tangible assets as part of total assets. So the Excess Returns model is suitable for determining the intrinsic value of STL rather than the traditional discounted cash flow model, which places emphasis on factors such as depreciation and capex.
The main belief 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 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)
= (0.11% – 11%) x $21.01 = $0.061
Excess Return Per Share is used to calculate the terminal value of STL, 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)
= $0.061 / (11% – 2.9%) = $0.74
These factors are combined to calculate the true value of STL’s stock:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $21.01 + $0.74 = $21.76
This results in an intrinsic value of $21.76. Given STL’s current share price of US$19.63, STL is , at this time, trading in-line with its true value. This means there’s no real upside in buying STL at its current price. Pricing is only one aspect when you’re looking at whether to buy or sell STL. There are other important factors to keep in mind when assessing whether STL 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 STL going forward? Our analyst growth expectation chart helps visualize STL’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether STL is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on STL 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 firstname.lastname@example.org.