Pricing bank stocks such as PACW 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. Focusing on factors such as book values, in addition to the return and cost of equity, is suitable for calculating PACW’s intrinsic value. Today I’ll look at how to value PACW in a reasonably accurate and uncomplicated approach. View our latest analysis for PacWest Bancorp
Why Excess Return Model?
Financial firms differ to other sector firms primarily because of the kind of regulation they face and their asset composition. United States’s financial regulatory environment is relatively strict. In addition, banks generally don’t have substantial amounts of tangible assets on their balance sheet. So the Excess Returns model is suitable for determining the intrinsic value of PACW rather than the traditional discounted cash flow model, which places emphasis on factors such as depreciation and capex.
How Does It Work?
The central belief for Excess Returns 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)
= (9.6% – 9.90%) * $39.71 = $-0.12
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)
= $-0.12 / (9.90% – 2.47%) = $-1.6
Putting this all together, we get the value of PACW’s share:
Value Per Share = Book Value of Equity Per Share + Terminal Value Per Share
= $39.71 + $-1.6 = $38.12
Given PACW’s current share price of $53.87, PACW is trading above what it’s actually worth. This means PACW isn’t an attractive buy right now. Pricing is one part of the analysis of your potential investment in PACW. There are other important factors to keep in mind when assessing whether PACW is the right investment in your portfolio.
Next Steps:
For banks, there are three key aspects you should look at:
-
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.
-
Future earnings: What does the market think of PACW going forward? Our analyst growth expectation chart helps visualize PACW’s growth potential over the upcoming years.
-
Dividends: Most people buy financial stocks for their healthy and stable dividends. Check out whether PACW is a dividend Rockstar with our historical and future dividend analysis.
For more details and sources, take a look at our full calculation on PACW 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.