Pricing consumer finance stocks such as YRD is particularly challenging. Given that these companies adhere to a different set of rules relative to other companies, their cash flows should also be valued differently. For instance, these lenders must hold a certain level of cash reserves on the books as a safety precaution. Emphasizing elements such as book values, with the return and cost of equity, may be appropriate for assessing YRD’s true value. Today I will show you how to value YRD in a fairly effective and straightforward way. View our latest analysis for Yirendai
Why Excess Return Model?
There are two facets to consider: regulation and type of assets. YRD operates in China which has stringent financial regulations. In addition to this, consumer financials generally don’t have large amounts of physical assets on their balance sheet. 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.
The main 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 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)
= (39.03% – 8.49%) * CN¥92.25 = CN¥28.17
Excess Return Per Share is used to calculate the terminal value of YRD, 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)
= CN¥28.17 / (8.49% – 2.47%) = CN¥467.59
Putting this all together, we get the value of YRD’s share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= CN¥92.25 + CN¥467.59 = $89.13
Given YRD’s current share price of CN¥39.87, YRD is currently priced below its intrinsic value. This means YRD can be bought today at a discount. Valuation is only one part of your investment analysis for whether to buy or sell YRD. Analyzing fundamental factors are equally important when it comes to determining if YRD has a place in your holdings.
For consumer financials, 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 YRD going forward? Our analyst growth expectation chart helps visualize YRD’s growth potential over the upcoming years.
- Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether YRD is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on YRD here.