Capital market firms such as HUB are hard to value. This is because the rules they face are different to other companies, which can impact the way we forecast their cash flow. For instance, these businesses must hold a certain level of cash reserves on the books as a safety precaution. Examining data points such as book values, on top of the return and cost of equity, is fitting for assessing HUB’s intrinsic value. Below I will take you through how to value HUB in a fairly useful and straightforward way. Check out our latest analysis for HUB24
What Is The Excess Return Model?
Before we begin, remember that financial stocks differ in terms of regulation and balance sheet composition. Strict regulatory environment in Australia’s finance industry reduces HUB’s financial flexibility. In addition to this, capital markets usually do not possess significant amounts 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 HUB’s True Value
The main belief for Excess Returns 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 in excess of cost of equity is called excess returns:
Excess Return Per Share = (Stable Return On Equity – Cost Of Equity) (Book Value Of Equity Per Share)
= (60.32% – 8.55%) * A$1.05 = A$0.54
Excess Return Per Share is used to calculate the terminal value of HUB, 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$0.54 / (8.55% – 2.76%) = A$9.35
Putting this all together, we get the value of HUB’s share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= A$1.05 + A$9.35 = A$10.39
Given HUB’s current share price of A$10.7, HUB is , at this time, fairly priced by the market. This means HUB isn’t an attractive buy right now. Valuation is only one side of the coin when you’re looking to invest, or sell, HUB. Fundamental factors are key to determining if HUB fits with the rest of your portfolio holdings.
Next Steps:
For capital markets, there are three key aspects you should look at:
1. 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.