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Pricing bank stocks such as BY 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, banks must hold a certain level of cash reserves on the books as a safety precaution. Focusing on elements like book values, on top of the return and cost of equity, is suitable for computing BY’s value. Today I’ll take you through how to value BY in a relatively effective and straightforward way. See our latest analysis for Byline Bancorp
What Model Should You Use?
There are two facets to consider: regulation and type of assets. BY operates in United States which has stringent financial regulations. Furthermore, banks generally don’t hold large portions of physical assets as part of total assets. As traditional valuation models put weight on inputs such as capex and depreciation, which is less meaningful for finacial firms, the Excess Return model places importance on forecasting stable earnings and book values.
How Does It Work?
The key belief for this model 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 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)
= (8.02% – 9.92%) * $17.95 = $-0.34
Excess Return Per Share is used to calculate the terminal value of BY, 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)
= $-0.34 / (9.92% – 2.47%) = $-4.58
Putting this all together, we get the value of BY’s share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $17.95 + $-4.58 = $13.37
Compared to the current share price of $21.3, BY is , at this time, priced above its true value. This means BY isn’t an attractive buy right now. Pricing is only one aspect when you’re looking at whether to buy or sell BY. Fundamental factors are key to determining if BY fits with the rest of your portfolio 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 BY going forward? Our analyst growth expectation chart helps visualize BY’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 BY is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on BY 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.