Bank Valuation. Part 1 – Earning Analysis

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VALUATON. Part 1. Earning Analysis

Intrinsic value of a stock is an important measurement that helps us to understand whether a stock is over or under valued. According to a general understanding in the academic world, the price of a stock will eventually match its value.

To quote Ben Graham who put it best when he said, “You don’t have to know a man’s exact weight to know that he’s overweight”. So we say that intrinsic value whilst important, cannot be the “holy grail” of what exactly is the value of a stock.

Simply put, the value of a stock relies on discounting future earnings into today’s dollars. It includes a lot of assumptions in the process. Intrinsic value calculations should however help us to make correct investment decisions.

Investing or trading a particular stock, our clients buy it for its earnings potential in capital growth and dividends. But there is a difference when we calculate intrinsic value of a bank versus a non bank stock.

We consider 7 key factors, they are as follows:

  1. The income derived from its deposit base;
  2. The growth of its deposit base;
  3. The bank’s Interest Rate Margin – the profit from their main operation: borrowing and lending;
  4. Income from their other financial products such as: business accounts, brokerage accounts, credit cards and so on;
  5. The soundness of its loan portfolio;
  6. Depth and integrity of management;
  7. Favorable geography.

http://www.stockrip.com/finance/how-to-calculate-the-intrinsic-value-of-a-bank/

Because all these factors are interconnected with one another, they all play their part in calculating a bank intrinsic value. You can see an example below:

According to this analysis, ANZ Bank and NAB are undervalued while CBA and Westpac are overvalued.

 

VALUATION. Part 2. Comparable analysis

Comparable analysis is another way to value banks. It involves the comparison of valuation multiples for bank stock with respect to a benchmark bank.

In making the comparison, we expect that our four banks may have similar prospects for growth and return on invested capital (ROIC).

The process begins by collecting the necessary information on each bank to perform the analysis. It would be an advantage if bank report is released at the same time.  However this is not the case here. For example, CBA releases their annual financial reports in August while ANZ Bank releases it in October. In this case, the earnings and revenue should be adjusted (multiplied by growth rate for that period). After calculating individual ratios for all companies in the group, we can calculate average for these ratios. Using these average ratios, we can stipulate an average intrinsic value for our benchmark stock.

You can see an example:

According to this analysis, ANZ Bank and NAB are undervalued while CBA and Westpac are overvalued.

 

 

 

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