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Insurance stocks such as ORI are hard to value. This is because the rules banks face are different to other companies, which can impact the way we forecast their cash flows. For instance, insurance firms that invest excess premiums are required to maintain a certain level of reserves to reduce the risk to shareholders. Focusing on line items such as book values, as well as the return and cost of equity, can be appropriate for estimating ORI’s valuation. Below we will look at how to value ORI in a relatively useful and easy approach. View our latest analysis for Old Republic International
Why Excess Return Model?
Let’s keep in mind two things – regulation and type of assets. The regulatory environment in United States is fairly rigorous. Furthermore, insurance companies generally don’t hold significant portions of physical assets on their books. 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.
The Calculation
The main 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 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)
= (9.36% – 8.49%) * $16.82 = $0.15
Excess Return Per Share is used to calculate the terminal value of ORI, 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)
= $0.15 / (8.49% – 2.47%) = $2.42
Putting this all together, we get the value of ORI’s share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $16.82 + $2.42 = $19.24
Compared to the current share price of $20.78, ORI is , at this time, trading in-line with its true value. This means there’s no real upside in buying ORI at its current price. Pricing is only one aspect when you’re looking at whether to buy or sell ORI. Analyzing fundamental factors are equally important when it comes to determining if ORI has a place in your holdings.
Next Steps:
For insurance companies, 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 leverage and risk.
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Future earnings: What does the market think of ORI going forward? Our analyst growth expectation chart helps visualize ORI’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 ORI is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on ORI 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.