Valuing LPLA, 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. Asset managers, for example, must hold certain levels of capital in order to maintain a safe cash cushion. Emphasizing line items such as book values, in addition to the return and cost of equity, is beneficial for determining LPLA’s valuation. Today we’ll take a look at how to value LPLA in a relatively effective and simple way. View our latest analysis for LPL Financial Holdings
What Model Should You Use?
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. Furthermore, capital markets generally don’t have large portions of tangible assets as part of total assets. Excess Returns overcome some of these issues. Firstly, it doesn’t focus on factors such as capex and depreciation – relevant for tangible asset firms – but rather emphasize forecasting stable earnings and book values.
Deriving LPLA’s Intrinsic Value
The key assumption 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)
= (43.74% – 10.75%) * $12.3 = $4.06
Excess Return Per Share is used to calculate the terminal value of LPLA, 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)
= $4.06 / (10.75% – 2.47%) = $49.03
Putting this all together, we get the value of LPLA’s share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $12.3 + $49.03 = $61.32
Relative to today’s price of $69.6, LPLA is trading in-line with its true value. Therefore, there’s a bit of a downside if you were to buy LPLA today. Pricing is one part of the analysis of your potential investment in LPLA. There are other important factors to keep in mind when assessing whether LPLA is the right investment in your portfolio.
Next Steps:
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 LPLA going forward? Our analyst growth expectation chart helps visualize LPLA’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether LPLA is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on LPLA here.