Valuing ETFC, a financial stock, can be daunting since these capital market firms generally have cash flows that are impacted by regulations that are not imposed upon other industries. For example, capital market businesses are required to hold more capital to reduce the risk to shareholders. Looking at line items like book values, along with the return and cost of equity, can be appropriate for evaluating ETFC’s intrinsic value. Below I will take you through how to value ETFC in a reasonably useful and simple approach. See our latest analysis for E*TRADE Financial
What Is The Excess Return Model?
Two main things that set financial stocks apart from the rest are regulation and asset composition. The regulatory environment in United States is fairly rigorous. In addition, capital markets generally don’t possess substantial amounts of tangible assets as part of total assets. While traditional DCF models emphasize on inputs such as capital expenditure and depreciation, which is less useful for a financial stock, the Excess Return model focuses on book values and stable earnings.
Deriving ETFC’s True Value
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 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)
= (13.09% – 9.65%) * $31.2 = $1.07
Excess Return Per Share is used to calculate the terminal value of ETFC, 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)
= $1.07 / (9.65% – 2.47%) = $14.98
These factors are combined to calculate the true value of ETFC’s stock:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $31.2 + $14.98 = $46.18
Relative to today’s price of $58.06, ETFC is trading above what it’s actually worth. Therefore, there’s no benefit to buying ETFC today. Valuation is only one part of your investment analysis for whether to buy or sell ETFC. Analyzing fundamental factors are equally important when it comes to determining if ETFC has a place in your holdings.
For capital markets, 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 leverage and risk.
- Future earnings: What does the market think of ETFC going forward? Our analyst growth expectation chart helps visualize ETFC’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether ETFC is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on ETFC here.