Pricing bank stocks such as USB 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 example, banks are required to hold more capital to reduce the risk to depositors. Examining elements like book values, as well as the return and cost of equity, may be useful for computing USB’s intrinsic value. Today I’ll determine how to value USB in a relatively useful and simple approach. See our latest analysis for U.S. Bancorp
What Model Should You Use?
Before we begin, remember that financial stocks differ in terms of regulation and balance sheet composition. Financial firms operating in United States face strict financial regulation. Furthermore, banks tend to not have large amounts of physical assets on their books. So the Excess Returns model is suitable for determining the intrinsic value of USB rather than the traditional discounted cash flow model, which places emphasis on factors such as depreciation and capex.
Deriving USB’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 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)
= (14.79% – 9.88%) * $29.39 = $1.44
We use this value to calculate the terminal value of the company, which is how much we expect the company to continue to earn every year, forever. This is a common component of discounted cash flow models:
Terminal Value Per Share = Excess Return Per Share / (Cost of Equity – Expected Growth Rate)
= $1.44 / (9.88% – 2.47%) = $19.47
Putting this all together, we get the value of USB’s share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $29.39 + $19.47 = $48.86
Compared to the current share price of $54.62, USB is currently fairly priced by the market. This means USB isn’t an attractive buy right now. Valuation is only one part of your investment analysis for whether to buy or sell USB. Fundamental factors are key to determining if USB 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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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 bad loans and customer deposits.
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2. Future earnings: What does the market think of USB going forward? Our analyst growth expectation chart helps visualize USB’s growth potential over the upcoming years.
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3. Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether USB is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on USB 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.