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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. Emphasizing elements like book values, on top of the return and cost of equity, may be appropriate for assessing ANZ’s value. Today we will look at how to value ANZ in a fairly accurate and uncomplicated method. Check out our latest analysis for Australia and New Zealand Banking Group
Why Excess Return Model?
Financial firms differ to other sector firms primarily because of the kind of regulation they face and their asset composition. ANZ operates in Australia which has stringent financial regulations. In addition to this, banks generally don’t hold substantial amounts of physical assets on their balance sheet. The Excess Returns model overcomes the required capital kept on hand and lack of tangibles by focusing on forecasting stable earnings, rather than less relevant factors such as depreciation and capex, which more traditional models focus on.
Deriving ANZ’s Intrinsic Value
The central belief 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)
= (11.8% – 8.55%) * A$21.42 = A$0.7
Excess Return Per Share is used to calculate the terminal value of ANZ, 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)
= A$0.7 / (8.55% – 2.76%) = A$12.01
These factors are combined to calculate the true value of ANZ’s stock:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= A$21.42 + A$12.01 = A$33.42
Relative to the present share price of A$26.72, ANZ is , at this time, trading below what it’s actually worth. This means ANZ can be bought today at a discount. Valuation is only one part of your investment analysis for whether to buy or sell ANZ. Analyzing fundamental factors are equally important when it comes to determining if ANZ has a place in your holdings.
Next Steps:
For banks, there are three key aspects you should look at:
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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.
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Future earnings: What does the market think of ANZ going forward? Our analyst growth expectation chart helps visualize ANZ’s growth potential over the upcoming years.
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Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether ANZ is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on ANZ here.
To help readers see pass 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.